IHS Global: Consumption and construction drive accelerating German GDP growth in Q4 while net exports represent sizeable burden

 

Frankfurt/Main ( 24.2.17) – Component data now released for the fourth quarter of 2016 confirms – as already shown by flash data released by the Federal Statistics Office (FSO) on 14 February – that German real GDP increased 0.4% quarter-on-quarter (q/q). This follows temporary weakness in the third quarter, when GDP only grew by 0.1% q/q, and it represents a return to the average growth pace during 2013-2016. The fourth-quarter expenditure breakdown broadly matches expectations formed on the basis of the FSO indications in their press release of 14 February, although export and import growth individually were much stronger than expected.

Thus imports grew at a clip of more than 3% while exports grew by almost 2%, leading to a burden of net exports on overall GDP growth of 0.4 percentage points that was even larger than the previous quarter’s burden of 0.3 percentage points. By contrast, domestic demand momentum picked up further, its quarterly growth pace accelerating from 0.5% to 0.8% q/q. Based on revised data, both private and public consumption growth strengthened compared to the third quarter, and fixed investment returned to positive growth after two quarters of decline. Equipment spending only improved in relative terms, however (still showing a marginal quarterly decline), whereas construction investment rebounded convincingly to robust positive growth. Changes in inventories supported GDP growth by a fair amount, just as in the preceding quarter, so that final domestic demand accelerated markedly to 0.5% q/q, following just 0.1% q/q in Q3. By comparison, average growth of final domestic demand during 2013-16 has been 0.4% q/q.

 

Meanwhile, the year-on-year growth rate of overall GDP unadjusted for calendar factors has decelerated modestly further from 1.5% to 1.2% y/y, having peaked at a five-year high of 3.2% in the second quarter of 2016. These numbers are heavily distorted by diverging calendar effects, however (three days more compared to the year-ago quarter in Q2, modest negative working-day effects in Q3 and Q4). The seasonally and calendar-adjusted series has in fact been virtually steady, showing 1.8% y/y in the first two quarters and also the final quarter of 2016, interrupted by 1.7% in Q3. As already revealed on 14 February, any revisions to quarterly growth were quite small, with upticks in the first two quarters of 2016 being followed by a slight downward revision of third-quarter GDP. The data prior to the past year has been left untouched anyway, as is the normal procedure for the February release. Overall, underlying annualized GDP growth momentum in the German economy should be considered fairly stable at modestly below 2% at present.

 

Looking at developments of the individual components in Q4 in more detail, the breakdown reveals the following about GDP growth contributions: Net exports subtracted 0.4 percentage points from quarterly GDP growth, following a similar burden of 0.3 points in Q3 but a positive contribution of 0.5 points in Q2. Domestic demand net of inventories added 0.5 points, thus rebounding from stagnation in Q2 and just 0.1% in Q3. The stock of inventories on their own added 0.3 percentage point to GDP growth, as in the previous quarter, but in contrast to subtractions averaging 0.2% in the two initial quarters of 2016. Companies have thus become emboldened to rebuild stocks again since mid-2016, notwithstanding the additional factors fanning geopolitical uncertainty that have emerged with the Brexit decision and the election of Donald Trump to the US presidency. This is quite remarkable. Among the components of final domestic demand, private and public consumption as well as fixed investment each contributed 0.2 percentage point to quarterly GDP growth. Within fixed investment, construction investment accounted for essentially all of this GDP contribution – growth in investment in equipment and also in “other investment” (intellectual property, livestock, agricultural crop) were relatively close to zero.

 

Private consumption growth at 0.3% q/q has strengthened versus the 0.2% pace of the two preceding quarters. Note, however, that Q3 growth was revised down from 0.4% originally, and the pace of 0.3% still pales against the 0.5% average seen between mid-2014 and mid-2016. The domestic environment for consumer spending remains fairly quite favourable – healthy labour market and wage developments and an ongoing extremely soft monetary policy by the ECB that keeps interest rates near record lows and thus renders saving unattractive – but the recent sharp upturn in headline inflation is a restraining factor for the near term.

 

Government consumption accelerated from 0.2% (revised down from 1.0% originally) to 0.8% q/q. This matches the quarterly average seen since mid-2014 and is quite high when compared with a quarterly average of less than 0.3% q/q during 2010-14. This development reflects an ongoing loosening tendency of German fiscal policy (more spending on infrastructure and slightly reduced income taxation) during the last 2-3 years, partly owing to the need to care for a large number of migrants/refugees. Furthermore, tax revenues continue to surprise to the upside, driven by growing employment and fairly healthy wage increases. This has already enabled budget surpluses of 0.3% and 0.7% of GDP in 2014 and 2015, respectively, and a separate release today has confirmed that the surplus has increased to 0.8% of GDP in 2016 – close to the post-unification high of 0.9% in 2000 that had benefited from the special factor of a sale of UMTS frequency licenses for mobile phone networks. This surplus has been possible despite the additional fiscal spending on migrants. Germany therefore remains in the favourable position of being able to provide fiscal stimuli without seriously risking renewed slippage into deficit in the foreseeable future.

 

Fixed investment increased 0.8% q/q in Q4, following interim declines of 1.5% q/q and 0.2% q/q in the second and third quarters, respectively. The latest rebound was mainly due to construction investment recovering from -0.3% q/q to 1.6% q/q, although investment in equipment also helped by curtailing their pace of decline from -0.5% to -0.1% q/q. That being said, equipment spending is still far from returning to the 1.2% average growth pace observed between Q2 of 2015 and Q1 of 2016. It is very likely that recent high levels of global uncertainty (Middle East unrest and associated terrorism, politically destabilizing impact of refugee crisis, Brexit fears, uncertain economic consequences of the Trump presidency) currently dampens the incentive to make long-term commitments based on expectations about future demand. Note that construction investment constitutes 49% of overall fixed investment versus 32.5% for investment in equipment and 18.5% for “other investment”. The latter component grew 0.3% q/q in Q4. Recent leading indicator evidence regarding the building sector, such as the construction sub-index of the Ifo business climate survey or the number of building permits (up 23% y/y during January-November 2016) suggest that construction sector activity will now remain strong during 2017. Separately, note that gross overall investment, i.e. including also inventories, has even strengthened from 1.5% q/q in Q3 to 2.4% q/q in Q4.

 

The negative contribution to GDP growth of -0.4% from external demand occurred despite robust growth of exports of goods and services (1.8% q/q, following -0.3% in Q3). Import growth was simply even stronger, rising to 3.1% q/q from just 0.4% in Q3. This strong increase in trade volumes indicates an acceleration of global demand that more than offsets the restraining effect of higher political uncertainty in the world at large. Imports are increasingly reflecting the robust domestic demand picture, and to some extent also the purchases of intermediate goods that are required for exports of finished goods. Looking back at the period since mid-2014, exports and imports have been growing at a solid average pace of 1.0% and 1.1% q/q, respectively. Note that the export orders component of Germany’s PMI survey, which had temporarily weakened from a 22-month high of 53.5 in December 2015 to 50.2 in March 2016, has since been recovering to the region of 55.0, even posting a three-year high of 56.7 most recently in February. Exports should thus continue to do well during the first half of 2017, arguing for a return of net exports to neutral ground for GDP growth in the coming quarters.

 

The latest indications gleaned from key leading indicators remain encouraging. Thus purchasing manager (PMI) data and the Ifo business climate survey have been rebounding again since March 2016, reaching new cyclical highs most recently. The main factors underpinning the optimistic outlook are the ongoing support to consumer purchasing power provided by healthy employment and wage growth and 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). Furthermore, residential construction enjoys an ongoing upward trend due to extremely favorable financing conditions and a lot of structural demand, not least also due to the large number of immigrants that require housing. Risks related to unexpected developments of Brexit negotiations, or major protectionist steps in the US, must be monitored, 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 Global Insight has projected in its February forecast round that calendar adjusted year-average German GDP growth, following 1.5% in 2015 and 1.8% in 2016, will accelerate slightly further to 1.9% in 2017. Unadjusted for calendar factors (as used for official government forecasts), growth will actually slip slightly from 1.9% in 2016 to 1.7% in 2017, as calendar factors swing from a positive effect of 0.1% in 2016 to a negative one of -0.2% in 2017. The underlying pace of economic growth is close to 2% now, and first-quarter GDP is even expected to show an above-average 0.6% q/q.

Timo Klein Principal Economist | IHS Markit Economics