IHS: German Q2 GDP details reveal final domestic demand

exceeded 3% growth pace in 2017 so far

 

Frankfurt/Main (25.8.17) – Component data now released for the second quarter of 2017 confirms – as already shown by flash data released by the Federal Statistics Office (FSO) on 15 August – that German real GDP increased 0.6% quarter-on-quarter (q/q). This is almost as strong as in the first quarter, although its 0.7% q/q had been boosted by above-average construction output due to the mild winter. The 0.66% q/q average for the first half of 2017 clearly exceeds the 0.4% average observed during 2013-2016.

 

Changes in inventories and net exports broadly offset each other in terms of their impact on GDP in both Q1 and Q2 of the current year, implying that final domestic demand, i.e. net of inventories, was broadly steady at 0.8% q/q in the first two quarters of 2017. This exceeds 3% in annualized terms and is twice as rapid as during 2013-16. Meanwhile, individual component data were close to expectations formed on the basis of the FSO indications in their press release of 15 August. Import growth outpaced export growth, so that net exports switched from being a support for overall GDP growth in Q1 (by 0.6 percentage points) to a burden to the tune of 0.3 percentage points. By contrast, total domestic demand contributed 1.0% to quarterly GDP growth, and only 0.2 percentage points stemmed from a build-up in stocks. All components of final domestic demand contributed strongly in Q2, be it investment (in both equipment and construction), private consumption, or public consumption.

 

The year-on-year growth rate of overall GDP unadjusted for calendar factors has nonetheless dropped back from a near-five-year high of 3.2% to 0.8% y/y, but this is exclusively due to a huge swing in calendar effects (three working days less instead of three days more compared to the year-ago period). By contrast, the seasonally and calendar-adjusted series has been almost steady just below the 2% level during most of the past two years (exception in Q4 2015 at 1.3% y/y) and has now increased modestly from 1.9% in Q1 to 2.1% in Q2. As already revealed on 15 August, revisions to data history going back to 2013 have had a net upward effect on levels in recent quarters. This has boosted full-year growth in 2016 from 1.8% to 1.9% and lifted the overhang effect for 2017 to such an extent that we have now raised the forecast for 2017 from 2.0% to 2.3% even though our predictions for quarterly growth from Q3 onward have not been changed materially. If the impact of changes to inventories is discounted, underlying annualized GDP growth momentum in the German economy has accelerated to the 3% area during the first half of the current year.

 

Looking at developments of the individual components in Q2 in more detail, the breakdown reveals the following about GDP growth contributions: Net exports subtracted 0.3 percentage points from quarterly GDP growth, having added 0.6 points in Q1 but also subtracted some 0.4 points each in Q3 and Q4 of 2016. Domestic demand net of inventories added 0.8 points, as in Q1, following just 0.5 points in Q4, 0.2 points in Q3, and zero in Q2 of 2016. The stock of inventories partially recovered from its marked depressing effect in the first quarter, swinging from -0.7 points to 0.2 points. As inventories had also contributed positively during the two latter quarters of 2016 (by 0.4 and 0.3 points, respectively), it can be said that the German economy took the additional factors fanning geopolitical uncertainty since mid-2016 (UK decision for Brexit, election of Donald Trump as US president) in its stride. Early 2017 concerns about populists potentially dictating the political agenda in key Eurozone countries after elections may have caused the first-quarter hesitancy of firms to build up stocks, but this was overcome with the election of Emmanuel Macron to the French presidency. Among the components of final domestic demand, private consumption contributed 0.4 percentage points to quarterly GDP growth, fixed investment 0.2 points, and public consumption 0.1 point (which adds up to 0.8% for final domestic demand using unrounded data). Within fixed investment, equipment and construction investment each contributed 0.1 point (helped by another very mild winter), while investment in equipment contributed 0.1 point. “Other investment” (intellectual property, livestock, agricultural crop) also contributed positively, but only to the tune of 0.02 points.

 

Private consumption growth doubled to 0.8% q/q in Q2, both in comparison with its growth in Q1 and the average during 2014-16. The marked upturn in inflation from roughly zero in early 2016 to around 2% in the initial months of 2017 had temporarily dampened real consumption, but the persistently favourable domestic environment for consumer spending due to healthy labour market and wage developments and very low interest rates given the ECB’s extremely soft monetary policy (rendering saving unattractive) has now led to a rapid rebound.

 

Government consumption accelerated from 0.2% (revised down from 0.4% originally) to 0.6% q/q. This almost returns to the 2014-16 average of 0.7% q/q, a period characterized by an ongoing loosening tendency of German fiscal policy (more spending on infrastructure and dealing with a surge in migrants/refugees; slightly reduced income taxation). 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%, 0.7%, and 0.8% of GDP in 2014, 2015, and 2016 respectively. This morning’s concurrent release of fiscal data for the first half of 2017, showing a surplus of 1.1% of GDP (a post-unification/post-1991 high), indicates that the tendency towards growing surpluses is not over yet. The fact that these surpluses have been possible despite the additional fiscal spending on migrants confirms that Germany 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 1.0% q/q in Q2, following 2.7% in Q1 (revised up markedly from 1.7%), which contrasts with slight net declines during the three latter quarters of 2016. In Q1, construction investment had been the main driver rather than equipment spending (3.4% versus 2.1% q/q, helped by a mild winter), whereas investment in equipment was slightly ahead in Q2 (1.2% versus 0.9% q/q). 1.2% q/q is also the average growth pace observed between Q2 of 2015 and Q1 of 2016, ahead of the above-mentioned stagnation phase that can be attributed to 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) that had reduced the incentive to make long-term commitments. Note that “other investment” as the third element of fixed investment increased 0.9% q/q in Q2. Recent leading indicator evidence regarding the building sector, most notably the construction sub-index of the Ifo business climate survey now available until August but also the most recent data about construction orders, points towards further strengthening of activity in the quarters ahead. Finally, note that gross overall investment, i.e. including also inventories, has recovered from its first-quarter dip to -0.8% q/q, rebounding to 2.0% q/q in Q2. This reflects the large positive swing of inventories from the first to the second quarter and thus has little significance in its own right.

 

The negative contribution to GDP growth of -0.3% from external demand owed to weakening growth in exports of goods and services (from 1.6% to 0.7% q/q) occurring alongside strengthening import growth (from 0.4% to 1.7% q/q). Nevertheless, trade volume growth in general remains robust now, mirroring renewed acceleration of global demand since late 2016. German imports are traditionally also boosted by the fact that higher exports of finished goods require an increase in purchases of intermediate goods. Looking back at the period since mid-2014, exports and imports have been growing at a solid and broadly equal 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 climbed to 61.1 in August 2017, its highest level in over seven years. Exports should thus continue to do well during the remainder of 2017 and also beyond, preventing net exports from becoming a burden on GDP growth despite the import pull exerted by strengthening domestic demand.

 

The latest indications gleaned from key leading indicators remain quite encouraging, with manufacturing PMI and Ifo business climate data being only slightly below multi-year highs in August (in the case of the Ifo index even just marginally below July’s all-time high since reunification in 1990). 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 due to the large number of immigrants that require housing. Finally, growth forces in Europe at large have been picking up since 2016, which is helping exports. Risks remain with respect to any unexpected developments of Brexit negotiations or major protectionist steps in 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 is now projecting that calendar adjusted year-average German GDP growth, following 1.5% in 2015 and 1.9% in 2016, will accelerate to 2.3% in 2017 and 2.1% in 2018. Unadjusted for calendar factors (as used for official government forecasts), growth will stay unchanged at 2.0% in 2017 due to calendar factors swinging from a positive effect of 0.1% in 2016 to a negative one of -0.3% in 2017. The underlying pace of economic growth can now safely be said to be exceeding 2% and indeed has been around 3% during the first half of 2017. Quarterly growth should fluctuate around 0.6% q/q in the next few quarters, with risks being skewed to the upside.

-Timo Klein  IHS Markit Principal Economis Economics