IHS Global: Halving of German GDP growth in Q1 overstates economic slowdown due to one-off and calendar factors

 

Frankfurt/Main (18.5.18) – Based on “flash” data released by the Federal Statistics Office (FSO), German real GDP increased 0.3% quarter-on-quarter (q/q) during the first quarter, down from 0.6% q/q in Q4 2017 (unrevised) and an average of 0.7% q/q during the four quarters of 2017. The diminished first-quarter increase slightly undershoots expectations that had already been toned down in recent weeks on account of fairly disappointing monthly frequency data such as production, trade, and retail sales. It appears likely that a strong second-quarter rebound will at least partially correct for the sub-average increase in Q1, because economic activity was dampened by a number of one-off and calendar factors.

The first quarter was marred by metal sector strikes, an unusually wide-spread flu epidemic, the early start to Easter holidays (much in March this year), and the lack of a regular budget due to the delay in forming a government after the September 2017 elections. Quarterly growth in Q2 may thus be not far below the 1% mark, followed by a quarterly growth pace of 0.5-0.6% during the remainder of 2018. It is worth remembering that the slippage of key leading indicators in recent months has been from record levels in late 2017, so that even the reduced levels as of April still reflect robust activity in a historical comparison. First-quarter growth of 0.3% is only modestly below the 0.4% average seen during 2013-2016. The statistical importance of first-quarter data for full-year growth nonetheless forces us to reduce our forecast for this year’s GDP outcome from 2.6% (as predicted in our April forecast round) to 2.4%.

 

Based on the calendar and seasonally adjusted series, the year-on-year rate for total real GDP has softened from a six-year high of 2.9% in Q4 2017 to 2.3% in the first quarter. Unadjusted for calendar effects, first-quarter annual growth even softened from 2.3% to 1.6% y/y due to the dampening impact from a sub-average number of working days.

 

Today’s “flash” release for the first quarter as usual encompassed only data for the overall GDP aggregate and not the individual components. The latter will only be made available on 24 May. Looking at the qualitative guidance provided by the FSO, the main driving force for growth in early 2018 was apparently fixed investment, with construction leading the way but equipment spending also contributing significantly. This represents a recovery from nearly stagnation during the second half of 2017. By contrast, private consumption, which had even slipped marginally in that period, only rebounded modestly, a far cry from the buoyant growth pace between mid-2015 and mid-2017 (average of 0.6% q/q). Public consumption even declined in absolute terms in Q1, which is closely linked to the above-mentioned absence of a regular budget due to the delay in forming a new government (the budget is only due to be passed in July). Finally, both exports and imports declined versus the previous quarter. As they appear to have slipped by a similar magnitude, net exports will have been broadly neutral for overall GDP growth. This contrasts with an average positive contribution of 0.4 percentage points in the two latter quarters of 2017.

 

The indications provided by the FSO suggest that, notwithstanding the noted constraints, domestic demand has strengthened somewhat compared to the final quarter of 2017. The FSO do not make any statements about changes in inventories, but we estimate they had a modest dampening impact. Therefore, final domestic demand (excluding changes in inventories) probably grew at an even faster pace, having barely exceeded stagnation in the two preceding quarters. This should encourage in light of the slippage of leading indicators such as manufacturing PMI and the Ifo index in recent months that had pointed to mounting concerns especially about protectionist and foreign policy measures by the Trump administration in the US. Indeed, consumer spending has been unusually subdued since mid-2017 now, implying an ongoing rise in pent-up demand due to the concurrent solid increase in income. The latter follows from the ongoing improvement in labour market and wage conditions. Furthermore, there is great (also international) pressure on the new grand coalition government to now expand spending on the military and infrastructure investment, as well as in various areas of the social welfare state to correct the increasingly disparate income distribution. Sizable budget surpluses at present increase the likelihood that this will indeed happen. Meanwhile, building activity, while battling with capacity constraints, continues to be driven by a combination of large demographic pressure for residential construction (including pent-up demand), persistently favorable financing conditions, and government efforts to boost infrastructure investment.

 

With regard to the external sector, monthly trade data had already indicated a weakening tendency in the first quarter. This affected imports more than exports in nominal terms, as import prices temporarily fell in early 2018. This will be compensated by the price adjustment with respect to the real data, however. Nevertheless, export growth has cooled too, having shown year-on-year growth in the high single-digits in late 2017. It seems that the anti-globalization policies of the Trump presidency are finally having a damaging effect. Furthermore, it needs to be kept in mind that lower imports are also indirectly hurting German economic growth due to reduced export potential (as second-round effects) – a net export contribution to GDP growth of for instance 0.2 percentage points is a different animal when this happens alongside export and import growth of roughly 6% each rather than only 3% each. On the other hand, the sizeable euro appreciation between May 2017 and January 2018 – from around USD1.07 to a peak of USD1.25 – has gone into reverse since mid-April, suggesting a boosting effect on export growth ahead due to higher competitiveness.

 

Notwithstanding the weak headline growth in the first quarter, annualized growth should remain in the 2% area for now. Labour market conditions are still improving, the refugee factor hardly becoming visible in the numbers. Stable employment growth of around 1.5% y/y is thus keeping any job concerns of consumers at historically low levels, while still extremely low interest rates should keep the savings propensity in check. The high oil prices of late are an offsetting factor for private consumption, however. Meanwhile, robust investment growth in the first few months of 2018, at the same time that PMI and Ifo leading indicator data have corrected sizably, is encouraging for the medium-term outlook. Building sector activity will continue to receive positive impulses from demographic influences and therefore not let up any time soon. Finally, the ECB is continuing to be very cautious about unwinding its extremely soft monetary policy and German fiscal policy will be biased towards expansion given record tax revenues and spending needs for refugees and infrastructure investment. In sum, IHS Markit expects Germany’s underlying annual growth pace to weaken from the 2.5-3.0% range observed during 2017 to the 2% area in the next few quarters.

 

Our GDP growth forecast for 2018 needs to be reduced from 2.6% (April forecast round) to probably 2.4%, but we are maintaining a prediction of 2.0% for 2019. This compares with 2.5% (calendar adjusted) in 2017. The anticipated slowdown mainly reflects developments in the external sector, whereas the domestic economy benefits from pent-up demand with respect to both consumption (private and public) and investment.  

–  Best regards, Timo Klein