German industry defies recession fears in May

Surprisingly strong industrial production defies recession fears as optimism is gradually returning to the eurozone's largest economy.

Industrial production is defying recession fears. In May, German industrial production increased by 0.9% month-on-month, from 0.2% MoM in April. On the year, industrial production was unchanged. The May increase was mainly driven by stronger production in the automotive industry (+3.6% MoM) but also increasing activity in the construction sector (+0.9% MoM).

Despite the war in the Middle East and soaring energy prices, industrial production is proving resilient. In the first two months of the second quarter, industrial production is actually up, not down. Some industries or companies actually seem to have benefited from the war in the Middle East, as Asian competitors were hit harder by the closure of the Strait of Hormuz.

Optimism is gradually returning

Looking ahead, the opening of the Strait of Hormuz, as well as easing geopolitical tensions (or simply the fact that everyone has started to accept that geopolitical tensions are part of the new normal), should bring a mild boost to the German economy. However, it won’t be a huge boost but rather a mild tailwind. Despite some improvement, production expectations in industry remain weak, and order books are only very gradually filling up again. More importantly, the lack of equipment as an impediment to industrial activity is increasingly a problem, hinting at potential new supply chain frictions. And these supply chain frictions are not only related to the Middle East but will increasingly be related to the European heat wave and drought, having reduced water levels in crucial waterways.

At the same time, the odds are increasing that Germany could break free from the current stranglehold of unfavourable exogenous shocks and reform paralysis. Even if it almost looks like a law of nature that after the Middle East war and the energy price shock, a new exogenous shock will be lingering somewhere, at least the reform paralysis has ended. Admittedly, at least for analysts, last week’s reform package could have been bolder, but presenting a package of health care and pension reform, deregulation and less bureaucracy, garnered with some labour market and tax reform, sends a strong signal that the government is willing (and able) to act.

It is not a package that will morph a stagnating economy into a booming economy overnight. It’s a package that also lacks a strategy for affordable energy and tax relief for companies. But it is a package that could create the preconditions, the framework, for future growth. The healthcare and pension reform will put public finances on a sustainable footing in light of demographic change, and the other structural measures could loosen the brakes for future growth.

Add to that the ongoing fiscal stimulus for infrastructure and defence, and the narrative for German growth turns more optimistic. It seems as if Germany has finally understood that economic success does not return simply or effortlessly. All in all, developments of the last weeks have provided tentative signs of optimism – for a change.

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