Timo Klein: Detailed German GDP data reveal inventory accumulation offset burden from net exports in Q2

Frankfurt/Main (24.8.18) – Component data now released for the second quarter of 2018 confirm – as already shown by flash figures released by the Federal Statistics Office (FSO) on 14 August – that German real GDP increased 0.5% quarter-on-quarter (q/q), or more precisely 0.45% q/q. This is modestly firmer than the 0.4% outcome in the first quarter (revised up from 0.3% released in May) and broadly in line with the quarterly average observed during 2013-2016. The latest growth pace only pales when compared with the 0.7% average during 2017, but this in turn was mainly due to a one-off surge by 1.1% q/q in the first quarter whereas the pace during the remainder of last year was only 0.56% q/q.

The headline number for Q2 hides a doubling of the momentum of domestic demand growth to 0.8% q/q while net exports subtracted 0.4 percentage points from GDP growth. However, final domestic demand, i.e. net of inventories, actually weakened slightly from 0.5% to 0.4% q/q, implying a major contribution by a build-up of inventories during the latest quarter. The latter can be attributed at least in part to efforts by exporters to bring forward deliveries in order to beat the (feared) US imposition of tariffs. Among the components of final domestic demand, public consumption rebounded after their first-quarter decline as the formation of a new government in March removed some of the budgetary uncertainty (although the final budget for 2018 was only passed in early July). By contrast, growth momentum of both private consumption and fixed investment waned, the latter due more to weaker growth of equipment spending than of construction.

 

Revisions to previous quarters, which go back four years every August (thus this time to 2014), were downwards for the second, third, and fourth quarters of 2017 but upwards for the initial quarter of 2018. This has curtailed the overhang effect for 2018 from 0.98% to 0.83%, dampening average growth in 2018 accordingly. This was only partly offset by the net upward revision to the first quarter of 2018, which was limited by a downward revision to fixed investment.

 

The year-on-year growth rate of overall GDP unadjusted for calendar factors has rebounded from 1.4% to 2.3% y/y. This purely reflects working-day effects, however, as the seasonally and calendar-adjusted series edged slightly lower from 2.0% to 1.9% y/y. This matches the average during 2014-16 but represents a weakening compared to the pace of 2.5% in 2017.

 

Looking at second-quarter developments of the individual components in more detail, the breakdown reveals the following about GDP growth contributions: Net exports subtracted 0.4 percentage points from quarterly GDP growth, contrasting with a roughly neutral impact in Q1 and additions of 0.3% each in Q3 and Q4 2017. Domestic demand net of inventories weakened slightly from 0.5% to 0.4% q/q, while inventories on their own contributed 0.4 percentage points to GDP growth. There has already been a net build-up of inventories since mid-2016, following rather depressed levels during 2014-15, but this is a fairly major additional step towards normalization. It remains to be seen, though, whether this is mainly related to exporters ramping up production in order to satisfy foreign demand to beat looming US tariffs or also a reflection of increased confidence about future domestic demand.

 

Private consumption growth of 0.3% q/q was weaker than in Q1 (0.5%) but remained solid compared to the mere 0.1% average during the second half of 2017. The latter was likely linked to the marked upturn in inflation from only around 0.5% in Q3 2016 to roughly 2% in early 2017, which hurt consumers’ spending propensity with a delay of a few months as they gradually became aware of rising prices. By the turn of the year 2017/18, consumers had become used to the new inflation environment, in addition to which healthy labour market developments and above-average wage settlements have provided fresh purchasing power during 2018 so far. The effect is exacerbated by interest rates remaining very low by comparison, so that consumers continue to find saving in interest-bearing instruments an unattractive alternative.

 

Government consumption rebounded by 0.6% q/q, having posted their first quarterly decline in almost five years in the preceding quarter (-0.3%). This represents an initial correction to the dampening impact caused by the postponed passage of a regular budget because of the 6-month delay in forming a new government after the September 2017 elections. In such cases, the administration is forced to temporarily run on the previous year’s budget. The coalition agreement in March will have removed some uncertainty, but only the final passage of the budget bill for 2018 in early July will have enabled more far-reaching expenditure plans to be realized. Public consumption should therefore accelerate further in the coming quarters as the projected loosening of German fiscal policy increasingly makes itself felt. Indeed, continued strong tax revenue growth and resulting budget surpluses (1.2% of GDP in 2017, likely 1.4% in 2018) suggest the government will be receptive to loosening Germany’s fiscal purse strings even further in 2019.

 

Fixed investment growth softened from 1.4% in Q1 (revised down from 1.7%) to 0.5% q/q. This finally reflects increasing global uncertainty levels during 2018, owing to US president Trump’s initiatives with respect to trade protectionism and Iran as well as the lack of progress in Brexit negotiations. Construction investment held up best at 0.6% q/q, but this was still down considerably from 1.6% q/q in Q1 that benefited from favourable weather conditions. The slowdown should be temporary, however – the construction sub-index of the Ifo business climate survey reached a new all-time survey high in July. Meanwhile, investment in equipment slowed from 2.3% (this revised up sharply from 1.2%) to merely 0.3% q/q, whereas “other investment” (intellectual property, livestock, agricultural crop) improved from -0.5% q/q (in this case revised down markedly from 1.5% initially) to 0.3% q/q. Note that gross overall investment, i.e. including also inventories, went into the opposite direction due to the surge in stocks, accelerating from 0.9% to 2.6% q/q.

 

External demand provided a significant negative contribution to GDP growth of -0.4% despite exports of goods and services recovering from -0.3% to 0.7% q/q. This is entirely due to imports rebounding much more strongly from -0.2% to 1.7% q/q. Trade volume growth generally improved during March-June, which partly mirrors efforts to circumvent imminent trade impediments triggered by US protectionism. The export orders component of Germany’s PMI survey has concurrently dropped from a 21-year high of 63.2 in December 2017 to 51.9 in July, suggesting that the underlying tendency for the coming months will still be pointing towards weakening. Imports should generally remain a little more resilient, arguing against any significant positive contribution from net exports to GDP growth in the foreseeable future.

 

The latest indications gleaned from key leading indicators lend the impression of some stabilization in underlying growth momentum during the second half of 2018. However, it should be kept in mind that some of the better-than-expected second-quarter GDP performance represented a correction for some negative one-off factors in Q1 (strikes, flu epidemic, constellation of public holidays, no regular government budget for 2018 available). Therefore, even if private and public consumption as well as construction investment seem poised to strengthen further in Q3 (the building sector profiting from persistently favourable financing conditions and a lot of structural demand), the burden from net exports in conjunction with possibly declining equipment spending are likely to provide an offset. On the bright side, the expansionary course of both monetary policy by the ECB and fiscal policy from the government (expenditures on refugees and infrastructure are rising, financed by the existing budget surplus) will remain in place throughout 2018 and in 2019. Risks remain with respect to any additional protectionist measures imposed by the US, but Germany’s domestic economy has developed a large degree of intrinsic resilience in recent years that should cushion any damaging external influences.

 

Overall, IHS Markit expects a quarterly growth pace of 0.4-0.5% q/q in the next few quarters, resulting in calendar adjusted German GDP growth of 1.9% in 2018 and 1.8% in 2019. Unlike the period 2015-17, when differences in working days had a major distorting impact, the growth forecasts in unadjusted terms (as used for official government predictions) are also 1.9% and 1.8% for 2018 and 2019, respectively.

– Best regards,Timo Klein