The Really Fat Years are Over for Now
by Dr. Ralph Solveen, Dep. Head Economic & Commodity Research, Commerzbank AG
In the past few months German sentiment has grown more sober as more and more people realise that the high growth rates of 2006 and 2007 are unlikely to be repeated in the near future. Growth this year will not exceed 11/2%, although this would still put the German economy back on the growth course that is expected medium term.
It’s not just about subprime
Even if many people were still expecting a lasting upswing in Germany in mid 2007, with growth rates of 2% or higher, the increasingly visible downturn did not come as a surprise. The subprime crisis in the US and the resulting turmoil on the financial markets are often cited as triggers, but their impact on the real economy will probably have been only limited, at least to date. The overall economic conditions, virtually ideal for several years, had in fact already started to deteriorate in the last months:
- With the ECB’s rate hike of 200 basis points in total between the end of 2005 and mid 2007, the strong tailwind that monetary policy had been giving the economy for some time changed into a headwind.
- Growth in foreign demand had been losing momentum on the back of the downward trend of the US economy since the start of 2007.
- The strong euro has severely weakened the price competitiveness of German and European products on the global market.
- Domestic demand has also suffered because of the substantial rise in energy and food prices.
Consequently, it is not very surprising that the year-on-year rise in real GDP was only 13/4% at the end of 2007, compared to nearly 4% a year earlier.
Weaker exports and investments
A far-reaching improvement is not in sight in the near term either. At the moment, everything suggests that the US economy will perform very weakly, at least in the first half of the year. Even if a deep recession can be avoided - and we assume it can - this will still put a firm brake on the global economy. The ongoing hopes that the global economy can be decoupled from the trend in the US are hardly likely to be met. The emerging markets have gained much importance in recent years, but they still cannot compensate for notably weaker demand from the US. The strong euro will also curb exports.
The strong euro has severely weakened the price competitiveness of German and European products on the global market.
The slower growth in foreign demand is unlikely to be offset by domestic demand. While the ECB is expected to cut interest rates in the next few months, the positive effect of this on investments and the overall economy will only start to show with the usual time lag of three to four quarters. An additional negative factor for investments will be that many projects were concluded last year, prior to the abolition of degressive depreciation as of the start of this year.
Too-high hopes for private consumption
This means that all hopes are pinned on private consumption. We, too, believe that, unlike in 2007, real growth can reach 1% again. There will not be an official consumption boom however, although some people do expect this on the back of the strong labour market and the anticipated stronger rise in wages. This is firstly because the weaker economy will also be reflected in lower payroll growth, which could even come to a standstill in the second half of the year. Secondly, the positive effect of stronger wage growth, which will probably fall short of expectations, is being exaggerated. It is often overlooked that employees’ net income only accounts for c. 40% of the disposable income of private households. The share of investment income and business income is of the same order of magnitude - and they will not increase at the same strong rates as in recent years, because of the weaker growth of the economy and the stronger rise in wages.
In 2009, the picture should look brighter again on the back of a stronger US economy and the rate cuts expected from the ECB in the next few months.
Last but not least, it is unlikely that private consumption will be boosted by a decline in the savings ratio. Past experience shows that in phases of positive trends on the labour market the savings ratio generally increases. While some people may look into the future with more confidence and are therefore prepared to spend more, it is more significant that those who have found a new job now want to replenish their shrunken reserves. In addition, the need for more private old age provision generally points to a rising savings ratio in any case.
Bottom line: More than 11/2% growth is not on the cards for 2008 (or for 2009).
Lower growth rates for exports, hardly any growth in investments, and private consumption that, while it is unlikely to fall, will see very limited growth - all in all, this indicates that the German economy will grow more slowly this year, at c. 11/2%, than in the previous two years. In 2009, the picture should look brighter again on the back of a stronger US economy and the rate cuts expected from the ECB in the next few months. Growth rates of 2% or even higher will not be within reach, however.