Last week’s news made for grim reading for many in Europe. First came the choice by our American friends to bring back to the White House a man who said just weeks ago that the EU would have to “pay a big price” if he won. Then the German governing coalition collapsed. Following factory closure announcements by VW in Germany a week before, the two largest German banks reported massive increases in their provisions for bad loans. Meanwhile, in France, lay-offs were announced by two high profile French companies in the automotive industry but also in retail a sector hitherto thought to be fine
The business climate in Germany (PMI and IFO surveys) deteriorated steadily from its peak in May to September. The relative optimism of the spring has ebbed away, as illustrated in particular by the deterioration in the PMI for export conditions (standing at 49.8 in September, compared to 51.9 in May). As a result, while our forecast for Q3 growth remains at 0.1% q/q, the German government has highlighted the risk of another negative figure (following the rate of -0.1% q/q in Q2 already) and therefore of a recession. Overall, GDP is likely to be close to its level recorded at the end of 2021 (i.e. three years of stagnation).
Germany and France follow different trajectories in terms of fiscal consolidation. The latter is more involved in Germany, where debt is more moderate. However, this is accompanied by a reduced support for the greening of the economy and a GDP stagnation over the last two years. In France, where public debt is higher, maintaining strong fiscal support has been accompanied by an increase in savings. The literature points out that, in this context, fiscal consolidation based on lower spending could support growth.
While there were signs of a rebound in German growth at the beginning of the year, the industrial recession was back from Q2 24, with a negative impact on the labour market that is now noticeable as the unemployment rate is rising. Against this backdrop and following the withdrawal of support for the purchase of electric vehicles in December 2023, households have increased their level of savings. However, there are still modest signs of a rebound, with a slight increase in demand. At the same time, the government’s awareness of the stalling of German industry could lead to the return of support measures.
Growth in exports to the United States (Germany's biggest export customer) has continued to drive German foreign trade in recent years, while trade with the eurozone and China has been relatively stagnant. For the past four months, however, the German PMI for export conditions has been above the threshold of 50 (albeit lower in June at 50.8 than in May at 51.9), suggesting a more global dynamic.
According to the expression “goods things come in threes”, France would meet Germany for the third time in the three lasts Euro football tournaments and win a third consecutive success. On the economic front, French results have already outpaced German results in three important areas over the past five years: job creation, investment growth and the transition to services. As a result, it is not surprising that France generated an additional 0.5 percentage point growth per year compared to Germany.
German growth is expected to be supported, in the short term, by the upturn in the country's industry, which should offset some of the loss of production associated with the rise in the cost of energy following the outbreak of the war in Ukraine. As an open economy, Germany is also expected to benefit from the rebound in growth in the eurozone since the beginning of 2024. However, in the longer term, German growth potential is likely to continue to suffer from labour shortages, from the weight of its industry (weakened by the low-carbon transition), and also from the consequences of insufficient investment against a backdrop of a surge in new competitors.
Europe is experiencing a losing trend in market share, due to the growth of other producers (Japan in the 1980s, China subsequently). In Germany, it even increased after the Covid-19 pandemic (-0.7 points in 2023 compared to 2019). The German chemical industry has been hit hard by rising energy prices and increasing competition from China and the US. Its automotive industry (which accounted for 17% of its exports in 2023) is suffering directly from Chinese competition.
The underperformance of German growth in recent years continued in 2023. However, even though it is no longer a driving force, the German economy is seemingly benefiting from the recovery seen elsewhere in the Eurozone, which could boost its growth in the coming quarters. This was reflected in a relatively good performance (0.2% q/q) in Q1, which, like the Eurozone's performance (0.3% q/q), surprised on the upside. The business climate (IFO) shows an improvement, albeit still partial, with an index of 89.3 in both May and April, making them the best two months since May 2023.
The German economy has been significantly underperforming the eurozone average and past standards for just over 6 years. The country might even be in recession again in Q4 2023 and Q1 2024. So has Germany bottomed out? From an economic point of view, this is likely because the moment of weakness, posted this winter, is partly due to exceptional effects. From a structural point of view, the German economy is expected to continue to post moderate growth, which would not allow it to regain its status as a driver of European growth.
The first indicators available for January point to a continuing weak start to the quarter (after contraction in GDP of -0.3% q/q in Q4 2023), hence our forecast of a further drop in GDP of -0.1% q/q in Q1. Manufacturing production (up 1% m/m in January) remained 1.5% below the figure seen in November, due to a sharp drop in automotive production (down 10% in January from the level seen in November).
Business climate and consumer confidence indices remained stable at a low level in February, highlighting Germany's limited economic impulse in Q1. According to our forecasts, GDP growth should be zero, after a contraction of 0.3% q/q in Q4: growth without momentum (for the time being) but also without a carryover effect (-0.2% after Q4 2023).
The recent decision of the German Federal Constitutional Court has fueled the debate on the debt brake, which imposes strict limits in terms of budget deficit. At the risk of oversimplifying, the question is whether fiscal policy should be based on an iron rule or a golden rule. The debt brake imposes fiscal discipline on future governments, which enhances fiscal policy credibility. However, its focus on the budget deficit implies that under realistic assumptions, public debt in percent of GDP will decline significantly. Proponents of the golden rule argue that, given the huge investment needs -green and digital transition, public support to innovation, etc
The cyclical slowdown in the German economy, which is similar to the one being experienced in the Eurozone, is part of a longer-term stagnation, with Q3 2022 standing out as the last quarter with significant growth. Even so, this figure is biased upwards, as the period benefitted from the post-Covid rebound. While the rise in energy prices was steep enough in 2022 to highlight the clear weaknesses of the German economy, which is specialized on energy-intensive sectors, some of these weaknesses had existed earlier. Against this backdrop, the prospect of a return to growth, which is our scenario for spring 2024, due to the drop in inflation in particular, is still shrouded in deep uncertainty and downside risk.
The business climate indicators highlight a still deteriorated situation, raising fears of another quarter of contraction in activity (-0.1% q/q in Q4 according to our forecasts), following four quarters of stagnation or decline (including -0.1% q/q in Q3). Indeed, the indices linked to current conditions in the IFO and ZEW surveys remained close to historical lows, in both industry and services. Expectations of a small improvement are based on the anticipation of the ECB’s monetary easing in 2024, which remained uncertain for the time being.
German exports of goods fell in October according to Destatis, continuing the trend seen over previous months. As a result, exports have been contributing negatively to German growth for almost a year, most notably exports to China. However, in October, exports to the European Union fell, after being hit by the decline in growth in the region.
Germany has just experienced four quarters of stagnation or negative growth, and business climate indicators suggest that economic activity remained broadly depressed at the beginning of Q4: current conditions of economic activity remain close to their lowest levels in both the IFO survey and the ZEW survey (-80 for the latter in November). In line with this depressed environment, production in key sectors (automotive, chemicals and metals) declined again in September (in Q3, it is now nearly 15% below the peak reached at the end of 2017 for each of these sectors). Exports do not drive growth as well (-6% y/y in Q3, trade balance figures in terms of value from Destatis).
Both France and Germany shed jobs in Q3 2023 as more and more companies struggled with sluggish demand. Against this backdrop, labour shortages are limiting less production, particularly in Germany, where they were more acute. However, these shortages are persisting, as they are structural, against a backdrop of low unemployment. Output from sectors with the strongest demand (i.e. aeronautics particularly in France) may suffer as a result, as well as development of sectors with the highest labour needs, particularly industries associated with the green transition (electrification and renovation).
German inflation resumed its downward trend, after stabilising between May and August (6.4% y/y in August according to the harmonised index), to reach 4.3% in September, due, firstly, to base effects (seasonally adjusted inflation was 2.3% m/m in September 2022, compared to a more normal 0.3% in September 2023). We expect a further drop in inflation of nearly 1 pp in October for the same reason (+1.1% m/m in September 2022 1 pp above the average for October over the last 15 years). Underlying inflation also fell to 4.8% y/y in September after a high of 6.3% in August 2023
The German economy is affected by the transmission of the inflationary shock to household consumption. However, the underperformance of the German economy also reflects more structural difficulties, reminding the “Standort Deutschland[1]” debate. These difficulties began in 2018 shortly before the first European regulations aimed at adapting the automotive sector to climate change were implemented. Manufacturing output has never returned to the November 2017 peak and production capacity in the sector has declined. Against a backdrop that is still difficult, we expect another recession in the second half of 2023.
German exports of goods increased by 2.6% y/y in the first 7 months of 2023 compared with the same period in 2022, but one usual destination is missing: China (-8%).
While Germany is barely coming out of a recession recorded in Q4 2022 and Q1 2023, economic surveys emphasise the risk that the country will fall back into recession in H2. The deterioration identified by IFO’s business climate is clear
Economic surveys pointed once again to a downturn, including the ifo Business Climate Index (88.5 in June compared to 93.4 in April) and the ZEW Indicator of Economic Sentiment (-14.7 in July compared to 28.1 in February). The erratic momentum of factory orders, which were up 6.4% m/m in May (after a low point in April 2023 not seen since May 2013), underlines one of the constraints at work: the irregularity of activity in transport equipment, which remains subject to sporadic supply difficulties. This phenomenon is generating high volatility in production, both in the aeronautics sector and the automotive sector (lower in April with an upturn in May, as also seen in France).
Germany experienced a technical recession in Q4 2022 (-0.5% q/q) and in Q1 2023 (-0.3% q/q), driven by a contraction in household consumption (-1.7% then -1.2%). Although the main cause of this recession was not its industrial core, the German economy showed signs of weakness which hindered growth. While disinflation should allow household consumption to recover in Q2, economic surveys however, are pointing to a further deterioration, which once again exposes the German economy to a risk of recession in H2.
While it might have been hoped that the current drop in inflation would provide a stronger boost to household confidence, this, and consequently consumption, remains constrained. This is due to the impact of rising interest rates on purchasing intentions in both France and Germany.
The Federal Republic of Germany is a parliamentary republic headed by a chancellor and a president. It comprises sixteen states (Bundesländer). Each state has its own state constitution, and is largely autonomous concerning its internal organisation. The most prosperous states are Bayern and Baden Württemberg in the southern part of the country. GDP per capita in these states are about 15% higher than the German average. The dynamism of the area is largely due to its sector specialisation. Manufacturing production makes up around 30% of production, and is concentrated in hi-tech industries.
With 83 million inhabitants the Federal Republic of Germany is the leading economy in the Eurozone both in population terms and its share of Eurozone GDP (more than one third). GDP per head is 20% above the Eurozone average, making it one of the most prosperous Eurozone countries. Germany is the world’s fourth largest economic power after the US, Japan and China, and the third largest exporter after China and the US.
The manufacturing sector plays a vital role in the economy. It accounts for almost 20% of employment and contributes almost a quarter of total value added. However, industry’s central role makes Germany’s economy more cyclical than some of its neighbours
