Germany

Oxford Economic Country Briefings, Dec 17, 2008

Highlights and Key Issues

* Germany appears to be slipping deeper into recession. The latest industrial figures are alarming: production fell 2.1% in October and orders were down 17.3%. If output remained at current levels to year-end, then Q4 would be down 3.2% on Q3, but the situation is deteriorating. The manufacturing PMI is below 40 and the expectations component of the lfo is at its lowest level since the first oil crisis in the early 1970s.

* Key to the rapid decline has been an abrupt halt to investment, both in Germany and globally. Investment in machinery and equipment had stalled in Q3 and domestic orders of capital goods then dropped 6% in both October and November. Business investment will fall by over 4% in 2009.

* But exports have also seen a rapid decline, having fallen in both Q2 and Q3, while export expectations are near all-time lows. Export volumes are expected to drop next year, despite the depreciation of the euro.

* We have slashed our growth forecasts, with GDP now likely to fall by at least 1 % in Q4. And we now do not expect the economy to emerge from recession until 2009H2 and for the economy to shrink by over 2% in 2009 overall - the biggest drop in over 60 years.

* Rapidly declining oil prices and an extended recession mean inflation could fall close to zero by next summer. Inflation has already slowed to 1.4% in November from a peak of 3.1% in July.

Overview

Slide into recession gathers pace...

* GDP contracted by 0.5% in Q3 and, after the 0.4% fall in Q2, Germany is now officially in recession. And the downturn appears to be worsening. The latest industrial figures are alarming: production dropped 2.1% in October and orders were down 17.3%. If output remained at current levels to year-end, then Q4 would be down 3.2% on Q3, but the situation is deteriorating fast. The PMI for manufacturing is below 40 and the expectations component of the lfo is at its lowest since the first oil crisis in the early 1970s. It seems likely that there will be a 1 %+ contraction in GDP in Q4 and that growth will average 1 .2% in 2008 as a whole.

...as investment tumbles...

* Key to the rapid decline since the summer has been an abrupt halt to investment - both in Germany and globally. Investment in machinery and equipment had already stalled in Q3 and domestic orders of capital goods dropped 6% in both October and November. And with business confidence plunging, investment plans are being dramatically scaled back. The DIHK survey of investment intentions shows business plans to reduce capital outlays and, with capacity utilisation set to fall further as the global economy falls into recession, investment is likely to weaken sharply. Business capital spending is forecast to drop by over 4% in 2009 and to stage only a modest recovery in 2010.

...and global recession hits exports

* Germany also exports a lot of investment goods capital goods accounted for 45% of total exports in 2007 - and exports of capital goods to Eastern Europe and Emerging Asia have been strong areas of growth in recent years. But these markets have been caught up in the financial crisis and exports to traditional markets such as other Eurozone countries have tumbled. The volume of exports had already fallen in Q2 and Q3 and, with foreign manufacturing orders falling 18% in October and November and export expectations close to all-time lows, the outlook is bleak. Export volumes are expected to drop next year, despite the depreciation of the euro, and to recover only slowly as the global investment cycle picks up in 2010.

Economy to contract 2% in 2009

* The decline in the business environment will also see firms shed jobs. Although unemployment continues to edge down and currently stands at 7.5%, survey evidence from the DIHK survey and lfo employment barometer shows employment is set to fall. As the economic slowdown bites harder, we expect the jobless rate to rise to over 9Y2% by end-2009. This will weigh on consumer demand - as will households' uncertainties about the economic outlook, which will encourage precautionary saving. We expect consumption growth to remain in negative territory and the savings ratio to climb further, despite the relatively low indebtedness of households.

* As a result of the rapid deterioration in economic conditions in Germany and globally, we have slashed our forecasts for GDP. We now expect Germany to remain in recession until at least 2009H2 and for the economy to shrink by just over 2% in 2009 as a whole - the biggest drop in over 60 years. The emergence from recession is also likely to be slow and we forecast growth of 1% in 2010.

* one piece of positive economic news can be found on the inflation front. Rapidly declining oil prices and an extended recession mean inflation could fall close to zero by the summer. Inflation has already dropped to 1.4% in November from a peak of 3.1% in July and is now forecast to average 0.7% in 2009 as a whole. The accompanying boost to household incomes is unlikely to be sufficient to offset the impact of higher unemployment, but it does release the shackles from monetary policy and allows the ECB to make further significant cuts to interest rates.