UBS Economics-European Economic Perspectives _Germany Still under pressur...-109914488

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European Economic Perspectives

Germany: Still under pressure but recession fears

overdone

 !"# 

While Eurozone growth surprised to the upside in Q2, rising 0.3% q/q, Germany

disappointed once more to the downside, with real GDP declining 0.1% q/q, the

weakest Q2 growth rate in the Eurozone except for Latvia. With sentiment indicators

weakening in June and July, this has raised fears about Germany falling into a technical

recession with two negative quarters of growth in Q2 and Q3. In this chart-based note,

we discuss the near-term outlook, the structural headwinds behind Germany's

underperformance, and crucially look at the resilience of the labour market. We update

our GDP forecast, lowering the 2024 growth rate to 0.1% (-20bp), but maintaining our

2025 forecast of 0.8%. We also review key data points and events to watch in H2.

$%&"'&#

Following growth of 0.2% q/q in Q1, German GDP has fallen again in Q2 by 0.1% q/q.

In our view, this negative growth number (and hence recession fears) should not be over-

interpreted, for three reasons. (1) According to destatis, the weakness in Q2 activity was

primarily due to investment, notably construction. Full details will only be published later

this month, but the monthly construction data shows a decline of 2.7% q/q in Q2 after

+2.5% in Q1. These swings in construction likely reflect positive weather effects that

boosted Q1 and reversed in Q2, implying that this factor should not weigh on Q3. (2)

The dataset behind this flash GDP estimate is very limited – in particular because retail

sales have not been reported after April ("delays due to new data requirements"),

perhaps increasing the risk of revisions. While the consumption data through April

suggests muted growth (with services consumption holding up better than goods), new

car registrations were very robust in Q2 (+7% q/q). (3) The Q2 GDP growth rate was -

0.08% q/q, hence the bar for a slight upward revision to zero growth seems low.

$&!%(%)))

Having said this, even taking the above factors into account, and if a technical recession

can be avoided, this still leaves a picture of very muted growth, and hence is a concern.

In particular, three headwinds are at work, in our view.

(1) Subdued global demand: Actual manufacturing orders remain at weak levels, despite

some pick-up in June, and the PMI orders subcomponent fell in June/July. On external

trade, both real exports and imports declined through Q2, with export weakness broad-

based across regions. This also feeds through to manufacturing production, but with

differing sector impact. While activity in energy-intensive sectors (such as chemicals)

increased in Q2 (+1.3% q/q) from low levels, non-energy-intensive sectors were very

weak (-1.5% q/q), notably driven by weakness in IT, and despite some pick-up in

transportation.

(2) Tight monetary policy: Less restrictive monetary conditions after the first rate cut

have yet to feed through to the construction sector, with housing construction permits

still on a downward trend.

3) Tight fiscal policy: The government is trying to limit the negative fiscal impulse on

activity, but meeting the debt brake in 2025 requires budget cuts and has led to ongoing

disagreements within the government coalition. The full extent of tightening will be

visible in the draft budget in mid-October. Our assumption is tightening of around ½%

of GDP, implying a growth headwind of around 20bp.

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Europe Ex. UK

'HI 

Economist

felix.huefner@ubs.com

+49-69-1369 8280

-

Economist

reinhard.cluse@ubs.com

+44-20-7568 6722

'JK'

Economist

franziska.fischer@ubs.com

+41-44-239 2054

,

Economist

anna.titareva@ubs.com

+44-20-7568 5083

! 19 August 2024 ab 2

)))!

That said, we continue to expect private consumption to pick up and offset some of the

above headwinds. Real disposable income of households – which has historically shown

a close correlation with consumption – rose 2.1% in Q1, more than double its long-term

average, and is set to accelerate further as employment ticked up in Q2, inflation

declined and nominal wage growth accelerated. Consumer confidence has also picked

up, in particular the intention to do major purchases. A key risk to this view is a

deterioration in the labour market, which could lead households to further increase their

precautionary savings (as they did in Q1). In July, the percentage balance of households

expecting higher unemployment over the next 12 months stood at 28.9%, slightly

above the 20-year average of 24% and a pre-Covid level of c.20% – not signalling

particular concern, but tracking labour market resilience will be key.

!K(%%L"'M&#

The labour market has started to weaken moderately, with unemployment now at

3.4%, up 50bp from its lows in mid-2023 (with the impact of Ukrainian refugees

registering with the labour office no longer distorting the signal from the registered

unemployment rate series) and the vacancy rate declining. Both measures, however, are

still close to historically tight levels. Labour shortages have declined from their peak, but

still one-quarter of manufacturing firms and one-third of services sector companies

report that a lack of labour is limiting activity. Leading labour indicators from business

surveys continue to signal further softening and companies are starting to use more

short-time work, albeit at low levels. Overall, there are clear signs that labour market

tightness is easing, but we see no signs of rapid deterioration.

N!OP% !L"'M&QR#

Taking a longer-term view, German GDP underperformance vis-à-vis its Eurozone peers

is not a recent phenomenon but dates back to at least 2019. The scale of the

underperformance remains striking: German real GDP is up 0.3% since Q4 2019,

compared with 4% in the Eurozone, 4.7% in Italy and 9.4% in the US. German real GDP

did not outperform France or Italy during Covid (refuting the expectation in 2020 that

Covid would introduce a north-south divide, with stronger growth in the north and

weaker in the south), and also during the energy crisis German growth was weaker than

others. At the sector level – and contrary to conventional wisdom – Germany's growth

performance since Q4 2019 has been particularly weak in services sectors (notably trade,

travel, accommodation, and arts and entertainment). German manufacturing has also

been weak, but its performance has been broadly matched by France. Hence, we do not

think the underperformance can be attributed only to the undeniable headwinds for

German industry (notably energy-intensive sectors and the car industry), but reflects a

broad weakening of potential growth (see Germany's growth weakness: Facts and

some hope). Estimates of Germany's potential growth rate have declined for several

years from 1½% during the 2010s to just below 1% now. Demographic ageing is a key

factor behind this trend (see here and here), but a lack of structural reforms and low

public investment are adding. Hence weaker German growth than in the Eurozone may

be a structural feature for the future, but should not prevent a cyclical pick-up from its

current stagnation.

N%LN11 "')QS&#

Apart from cyclical indicators, we will watch in particular three scheduled events over

the next few months. (1) The IG Metall wage negotiations, which cover 9% of all

employees and will be crucially watched by the ECB, given its importance for the

inflation outlook. IG Metall is demanding a wage increase of 7%, down from a demand

of 8% in 2022 (with an eventual settlement at 4.8%), but above the 5-6% range that

was typical in pre-Covid wage rounds. The old wage contract runs out on 30 September,

negotiations are set to start in mid-September, and strikes are allowed after 28 October.

(2) State elections in three east German states: Saxony and Thuringia (1 September) and

Brandenburg (22 September). Current polls suggest that parties from the far right and

far left might perform strongly, gaining a combined 40-50% of votes, complicating

coalition building, with potential implications for the federal government (next federal

election is in September 2025). (3) Amidst ongoing discussions about the 2025 budget

and specifically how to meet the strict debt-brake fiscal rule while limiting the negative

fiscal impulse on the economy, the focus will be on the draft 2025 budget that will be

sent to Brussels by mid-October.

! 19 August 2024 ab 3

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100

105

110

115

Jan-18 Sep-18 May-19 Jan-20 Sep-20 May-21 Jan-22 Sep-22 May-23 Jan-24

Eurozone France Germany Italy Spain US

Source: Haver, UBS

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(4)

(3)

(2)

(1)

GDP2022q1 vs 2019q4 GDP 2023q3 vs 2022q1 GDP2024q2 vs 2019q4

Eurozone Germany France Italy Spain

Covid 2020/21 Energy crisis

2022/23 Since pre-Covid

Source: Haver, UBS

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100

105

110

115

Jan15 Dec15 Nov16 Oct17 Sep18 Aug19 Jul20 Jun21 May22 Apr23 Mar24

ifo current situation ifo expectations ifo business climate

Source: Haver, UBS

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(8)

(6)

(4)

(2)

(6)

(5)

(4)

(3)

(2)

(1)

Jan18 Sep18 May19 Jan20 Sep20 May21 Jan22 Sep22 May23 Jan24

Composite PMI Germany ifo business climate

Source: Haver, UBS

'MT ! W.! 1J&

(4)

(3)

(2)

(1)

Jan18 Aug18 Mar19 Oct19 May20 Dec20 Jul21 Feb22 Sep22 Apr23 Nov23 Jun24

PMI Mfg Germany ifo manufacturing climate

Source: Haver, UBS

'RT W.1J&

(8)

(6)

(4)

(2)

Jan18 Jun18Nov18Apr19Sep19Feb20 Jul20 Dec20May21Oct21Mar22Aug22Jan23 Jun23Nov23Apr24

ifo services climate PMI Services Germany

Source: Haver, UBS

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abEuropeanEconomicPerspectivesGermany:Stillunderpressurebutrecessionfearsoverdone!"#WhileEurozonegrowthsurprisedtotheupsideinQ2,rising0.3%q/q,Germanydisappointedoncemoretothedownside,withrealGDPdeclin...

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