Research Euroland

Germany: Recession looming

Wed, Jul 16 2008, 14:03 GMT
by Danske Research Team

Danske Bank A/S


  • • Germany is the last man standing in the Euroland economy, but it is suffering from a deteriorating international environment and sluggish domestic demand. If Germany falls it will have a profound effect on Euroland growth - and downside risks have risen markedly in just a few months.
  • • Although the German economy is in relatively good shape, it cannot shield itself from deteriorating export markets that are giving in to the massive headwinds that have hit most of Germany's trading partners. Domestic consumption is very unlikely to make up for the fading demand from export markets, as consumers are suffering high inflation rates that are eroding purchasing power, and the rather strong employment growth of recent years is coming to an end. Furthermore, investments cannot fill the gap, as they are very sensitive to exports.
  • • Thus the German economy is facing a tough time. Negative growth will probably be seen in Q2 due to the underlying weakening of the economy, but because of the unwinding of special effects (i.a. a reversal of the warm weather effect on production, and the build-up of unintended inventories). We expect the economy to stagnate in Q3, but there is a risk of contraction. For 2008 as a whole, we expect GDP to grow by 1.6%. Growth is forecast at 1.1% in 2009, but this may prove too optimistic.
  • • What does this mean for ECB interest rates? One thing is sure - it will be harder for the ECB to hike rates further. Furthermore, the 'north-south' tensions in Euroland will evaporate as the conflicting interests of the 'hardliners' in the north (with relatively moderate inflation and high activity) and the doves in the south (with relatively high inflation and fading economic growth) diminish. Whether this means that rate cuts are just around the corner is another question, however. It remains to be seen, for example, how the ECB will interpret the expected rise in core inflation later this year and Euroland wage growth, which we forecast to stay rather elevated well into 2009 despite slow economic growth.

Published on  Wed, Jul 16 2008, 14:10 GMT

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