Germany

Oxford Economic Country Briefings, Nov 6, 2008

Highlights and Key Issues

* The financial turmoil is hitting home in Germany: after the euro50 billion package for Hypo Real Estate, the government is now offering to guarantee interbank loans to the tune of around euro400 billion with a further euro70 billion available for the direct recapitalisation of banks. Growth in bank lending has been a relatively modest driver of domestic demand but the economy is exposed as export markets suffer.

* Export prospects have slumped. So far, this has been mainly for exports to the Eurozone. These are likely to deteriorate further, but growth markets such as Russia and Central Europe are also being drawn into the crisis - businesses' export expectations are at their lowest since 2001.

* Deteriorating business sentiment will also have repercussions in the labour market, weighing on consumer demand - as will households' own uncertainties about the economic outlook, despite Angela Merkel promising to guarantee savings. Recession now seems unavoidable. We expect GDP to contract by 0.3% in 2009 - the first annual decline since 2003.

* A supportive factor in a harsh economic landscape is the sharp drop in oil prices. Already inflation has eased back to 2.4% in October from a peak of 3.3% and should fall sharply as the most recent drop in oil prices feed through. We expect inflation to soon be back below 2% and average 1.7% in 2009 as a whole.

Overview

Government bails out banks...

* The financial turmoil is hitting home in Germany: after the euro50 billion package for Hypo Real Estate, the government is now offering to guarantee interbank loans to the tune of around euro400 billion with a further euro70 billion available for the direct recapitalisation of banks. Hypo Real Estate has already made additional claims, and Commerzbank has taken euro8.2 billion to increase Tier 1 capital. The Landesbanks West LB and HSH Nord Bank are also in need of support. However, the biggest German bank, Deutsche Bank, has not requested government support.

* Bank lending has been a relatively modest driver of domestic demand in Germany as households have been prudent and Germany has not experienced a housing boom. But German banks are caught up in the difficulties hitting interbank markets as well as through forays into foreign markets. The economy is also exposed as export markets suffer and, in particular, as investment is scaled back.

...as economic outlook worsens...

* Exports slumped in August, reflecting the fall in export orders seen this year. So far, this has been mainly for exports to the Eurozone. These are likely to deteriorate further, but growth markets such as Russia and Central Europe are also being drawn into the crisis - businesses' export expectations are at their lowest since 2001 . We expect the volume of exports to stall next year as growth in export markets slows and this disproportionately hits demand for investment goods. The fall in the euro will help relieve some pressure on exporters' margins but is unlikely to be much of a fillip for export volumes.

* The rapidly slowing economy has resulted in a sharp deterioration in business confidence -the lfo has tumbled since May and now stands at its lowest level since 2003, with business' expectations for the coming 6 months at their lowest ebb since reunification. This will hit investment hard as firms delay expansion plans: according to the DIHK, firms are planning to cut back investment for the first time since end-2005. We expect business investment to decline by 2% next year, with the risk the outturn could be much worse.

...and economy falls into recession

* The decline in the business environment will have repercussions in the labour market. Although unemployment continues to edge down, survey evidence from the DIHK survey and lfo employment barometer shows the tide is turning. As the economic slowdown bites harder, we expect unemployment to rise to over 9% by end-2009.

* This will weigh on consumer demand - as will households' own uncertainties about the economic outlook, despite Angela Merkel promising to guarantee savings. With consumption growth expected to remain in negative territory, export growth to slow and private investment to fall, recession seems unavoidable. We expect the economy to have seen sharp declines in 2008H2 and to stagnate in 2009. Overall, we expect GDP to contract by 0.3% in 2009 - the first annual decline since 2003.

Government loosens fiscal shackles

* The deteriorating economic backdrop has resulted in a fiscal stimulus package appearing on the political agenda. The main measure consists of tax breaks on investment for the next couple of years to encourage firms to bring forward investment plans, with a particular focus on encouraging purchases of commercial vehicles, as well as measures to provide credit to the Mittelstand and funding for government infrastructure projects. The estimated cost for the package is euro35 billion over the next couple of years. As a consequence, the government has pushed back the date for bringing the budget into balance to 2013 from the originally planned 2011.