IHS Global: German Q2 GDP growth softens to slightly weaker-than-expected 0.6% q/q on restraining effect of surging imports

 

Frankfurt/Main (15.8.17) – Based on “flash” data released by the Federal Statistics Office (FSO), German real GDP increased 0.6% quarter-on-quarter (q/q) during the second quarter, down slightly from an upwardly revised 0.7% q/q in Q1 (originally released at 0.6%). Although second-quarter headline growth is slightly softer than the recent 0.7-0.8% market consensus expectation, significant upward revisions to Q3 2016 and Q1 2017 – part of the usual revisions of the last four years that take place every August – mean that the level of GDP in Q2 is actually almost 0.5% higher than expected. Full-year growth in 2016 was also lifted from 1.8% to 1.9% (calendar-adjusted). Average quarterly growth of 0.7% in the first half of 2017 represents significant strengthening compared to the 0.4% average during the period 2013-2016.

 

The FSO highlights that external trade exerted a restraining effect on second-quarter GDP growth due to imports growing “much more strongly” than exports. This is similar to the two latter quarters of 2016, whereas exports had outperformed in the first quarter of 2017. The wording suggests to us that net exports on their own dampened quarterly GDP growth in the vicinity of 0.5 percentage points. Conversely, this means that domestic demand grew by roughly 1.0% q/q. The FSO confirm that private as well as public consumption grew “markedly” and that all investment components (equipment, construction, other investment) also made positive contributions. Regarding construction, this is notable as a recoil effect had been expected due to Q1 activity having been boosted by unusually mild winter weather. As such, it seems unlikely that Q1 strength in overall demand owed much to a build-up in stocks, so that final demand may have come close to the 1% area too. Based on the calendar and seasonally adjusted series, the year-on-year rate for total real GDP has increased from 1.9% (revised up from 1.7%) to 2.1%. This is the strongest pace since early 2014. Unadjusted for calendar effects, however, second-quarter annual growth dropped sharply from 3.2% to 0.8% y/y, given a huge swing in calendar effects (three working days less instead of three days more compared to the year-ago period). The IHS Markit forecast for second-quarter GDP growth had been only 0.5% q/q and thus well below market expectations but only modestly below the actual outcome. Given the upward revision to Q1, the prediction of slightly smaller momentum in Q2 than in Q1 was indeed accurate. Notwithstanding July downward corrections to some leading indicators, we expect ongoing growth at a pace of 0.6-0.7% q/q in the next few quarters. Our GDP growth forecast for 2017 will need to be raised from 2.0% to 2.3% (which equals 2.0% in non-adjusted terms), although this is largely linked to above-mentioned upward revisions to recent history and not a stronger growth profile in coming quarters. The growth forecast for 2018 can therefore stay at 2.1% (as shown in the August forecast round to be released tonight), although an upward adjustment is more likely than a downward adjustment in future.

 

Today’s “flash” release for the second quarter as usual encompassed only data for the overall GDP aggregate and not the individual components. The latter will only be made available on 25 August. Looking at the qualitative guidance provided by the FSO a little more closely, it seems clear that strength in both private and public consumption was the driving force in Q2. At the same time, fixed investment is likely to have lost some momentum compared to Q1 (then 1.7% q/q ahead of any revisions), but it seems that this slowdown was less pronounced than we had expected. In sum, final domestic demand, i.e. net of inventories, which had been only 0.25% q/q on average during the second half of 2016 before accelerating to 0.6% q/q in Q1 2017, should have picked up further to nearly 1% q/q. Such a pace was last observed in late 2015 and early 2016. IHS Markit estimates that inventories, which had depressed GDP growth by about 0.3% in Q1, rebounded modestly in Q1 and thus also contributed to some degree to Q2 activity. Underlying factors impacting private and public consumption remain very supportive, the former being underpinned by the ongoing improvement in labour market and income conditions and the latter by expenditures for refugees. Meanwhile, the anticipated recoil effect in the construction sector linked to the Q1 boost from a mild winter seems to have been less of a dampening factor than expected. Building activity is being driven in underlying terms 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. Separately, investment in equipment appears to have shed the shackles of global political uncertainty linked to events such as the Brexit and the US election outcome. The initial months of the Trump presidency have demonstrated that the threat of the US severely disrupting global trade patterns via protectionist measures is smaller than had been feared initially.

 

With regard to the external sector, monthly trade data had already indicated that imports would outpace exports in Q2, although the extent of this outperformance seems to exceed expectations. Importantly, exports are continuing to grow too, which signals generally accelerating economic activity globally. Exports are coping well with the anti-globalization challenges posed by events such as Brexit and the Trump presidency in the US, and accelerating demand in the Eurozone economy at large is increasingly becoming supportive as most countries previously hindered by fiscal consolidation needs due to the debt crisis have left this behind. Robust German domestic demand since 2014 has contributed to this Eurozone recovery via strengthening German imports, for which the current Q2 release represents further evidence. Keep in mind that this is also benefiting the German economy via increased export potential (as second-round effects). The one factor that will restrain exports in the coming months is the degree to which the euro has appreciated recently. Overall, net exports will be roughly neutral with a slight bias towards a dampening direct effect in the coming quarters. However, it is worth remembering that strengthening growth of both exports and imports also has positive knock-on effects for domestic demand growth.

 

As already since mid-2016, German GDP will be driven foremost by robust domestic demand in the foreseeable future. The labour market has retained its improving trend for longer than had been expected in view of the impact from refugees that are increasingly looking for work after their asylum applications have been processed. Employment growth has remained very robust, keeping job concerns at historically low levels, and still extremely low interest rates are holding down the savings propensity. With regard to investment in equipment, the PMI sub-index for orders reached a six-year high in June before correcting somewhat in July, whereas the Ifo business climate index even reached an all-time high (for post-1991 and thus post-reunification times) in July. Building sector activity will continue to receive positive impulses from demographic influences and therefore not let up any time soon. Oil prices are remaining fairly low when compared with 2011-14, the ECB will be very cautious about unwinding its extremely soft monetary policy, and German fiscal policy will also remain 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 be near 2.5% in the next few quarters, which is higher than the roughly 2% pace expected a quarter ago.

 

The already completed August round GDP growth forecast for 2017 is 2.0%. Today’s Q2 evidence, in particular the accompanying upward revisions to recent history, will necessitate a further increase to 2.3%. The latter translates to 2.0% in calendar-unadjusted terms. For 2018, we are predicting 2.1%, raised from 2.0% in the July round (the forecasts are identical in unadjusted terms). This can be maintained for now, although risks are certainly skewed to the upside.

– Timo Klein