German: GDP growth strengthens in Q2 as revisions smoothen the path of recent quarters

Frankfurt/Main (14.8.18) – “Flash” data released by the Federal Statistics Office (FSO) shows that German real GDP increased 0.5% quarter-on-quarter (q/q) during the second quarter, up from an upwardly revised 0.4% q/q in Q1 (initially 0.3%). However, the customary August revisions of the last four years (back to 2014 this time), while revealing a slightly higher GDP level for the first quarter than before, have also resulted in somewhat lower growth during the second, third, and fourth quarter of 2017 than published previously. A now very strong first quarter of 2017 (1.1% q/q) means that full-year growth last year is still 2.5%, but the overhang effect into 2018 – i.e. average growth in 2018 hypothetically obtained if the GDP level remained unchanged throughout the year – is curtailed from 0.98% to 0.83%. By itself, this necessarily dampens the growth forecast for 2018 as a whole by 0.15 percentage points.

Nevertheless, the growth strengthening from the first to the second quarter confirms expectations based firstly on improving or at least stabilizing monthly frequency data such as PMI, production, trade, and retail sales, and secondly on the anticipated correction for a number of one-off and calendar factors that had dampened first-quarter activity – 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. Second-quarter growth of 0.5%, while representing a slowdown compared to the 0.7% average in 2017, nonetheless exceeds the 0.4% average of 2013-2016.

 

Based on the calendar and seasonally adjusted series, the year-on-year rate for total real GDP has softened slightly further from 2.0% to 1.9%, having peaked at 2.8% in Q4 2017. Unadjusted for calendar effects, however, annual growth actually accelerated from 1.4% y/y in the first quarter to 2.3% y/y in the second due to the swing from a dampening to a boosting impact of working days.

 

Today’s “flash” release for the second quarter as usual encompasses only data for the overall GDP aggregate and not the individual components. The latter will only be made available on 24 August. Looking at the qualitative guidance provided by the FSO, domestic demand was solely responsible for growth in the latest quarter, as rising exports were outpaced by even more strongly increasing imports. Among domestic demand components, both private and public consumption were the main drivers, but fixed investment in all its sub-components (equipment, construction, “other”) also contributed to some extent. That said, growth momentum of investment likely weakened considerably compared to the 1.7% q/q pace of the first quarter. By contrast, public consumption, which had even declined in absolute terms in Q1 due to the delayed passage of the budget for 2018 because of the extended process to form a new government, apparently recovered and should do so even more in the third quarter as parliament only finally passed the budget bill in early July. Overall, the indications provided by the FSO suggest that domestic demand has strengthened even further in the second quarter, although this may partly be because of a build-up of inventories that corrects for a dampening impact in the two preceding quarters. Nevertheless, even final domestic demand (excluding changes in inventories) should have at least maintained the robust pace of 0.5% q/q seen in Q1 if net exports actually subtracted from GDP growth as seems likely.

 

The apparent weakening of net exports – though less so exports on their own – reflects mounting concerns about US-led protectionism and problems in several emerging markets hit by a stronger dollar and increasing US interest rates. This has been the main reason behind the slippage of leading indicators such as manufacturing PMI and the Ifo index since the start of 2018. Rising competitiveness linked to euro depreciation since mid-April will prove at best a partial offset to these forces that are restraining global trade growth. By contrast, the German consumer is actually emboldened compared to the second half of 2017, based on accelerating income growth due to the ongoing improvement in labour market and wage conditions. Furthermore, fiscal policy of the new grand coalition government has shifted to a more expansionary stance (more on the spending side than with respect to taxes) despite holding onto their goal of a balanced budget also in the medium-term. This year and probably even in 2019 there will actually continue to be sizable budget surpluses. Finally, building activity, while battling with capacity constraints, remains 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.

 

In sum, annualized growth should remain close to 2% for now, given ongoing solid employment growth near 1.5% y/y and the recent boost to wages and pensions that is supporting consumer demand. Persistently low interest rate levels are also helping by keeping the savings propensity in check. Although investment in equipment is likely to suffer from heightened global uncertainty in the second half of 2018, building sector activity should power ahead for demographic and thus structural reasons. Finally, the ECB is continuing to be very cautious about unwinding its extremely soft monetary policy and German fiscal policy has now become more loose. IHS Markit expects Germany’s underlying annual growth pace to therefore stabilize at 2% or slightly below in the next few quarters, rather than weakening precipitously.

 

Our GDP growth forecast for 2018 will nonetheless need to be reduced from 2.2% (July forecast round) to 1.9%, half of which reflects the downward revisions to growth in the latter quarters of 2017. We maintain a prediction of 1.8% for 2019. The slowdown compared with growth of 2.5% in 2017 mainly mirrors developments in the external sector, whereas the domestic economy remains well supported by consumption (private and public) and investment in construction.

Best regards, Timo Klein