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Global Economic Outlook

Germany Outlook: Broad-Based Upswing Continues

By Katharina Jungen

  • Following record-breaking growth in 2010, further positive developments are in store for the German economy as domestic factors increasingly support the exports-led economic upswing.
  • RGE expects to see a sharp rise in investment activity in 2011 given favorable financing conditions, nearly recovered capacity rates and the positive economic outlook.
  • Despite inflation reaching 2%, upward pressure on prices will remain moderate as significant second-round effects are not yet evident.

Macroeconomic Dynamics: Economic Prospects Remain Very Favorable

The German economy is set to power ahead in 2011, indicated by high-flying business and consumer sentiment surveys and full order books. The initially export-led economic upswing, which had already received growing support from domestic demand in 2010, will broaden further given the positive outlook for investment activity and private consumption. Despite the contribution from the external sector moderating, GDP growth will remain significantly above potential, not least due to a sizeable carry-over effect of 1.2% from 2010. RGE expects buoyant GDP growth of 2.8% in 2011, boosted by a sharp rebound in construction activity following the weather-related slump at the turn of 2010/11. Although the economic outlook remains favorable for 2012, the pace of economic expansion is set to slow to 2.2% as economic growth rates converge back toward the long-term average.

The German economic recovery will be increasingly domestically driven. Over the forecast horizon, the outlook for investment remains particularly bright as suggested by firms’ ambitious investment plans. With capacity utilization rates back at long-term levels in many sectors, the favorable economic outlook, rising profit expectations and firms’ strong balance sheets bode particularly well for investment in machinery and equipment. RGE expects investment activity to grow at close to 10% in 2011. Private consumption continues to strengthen in light of the highly favorable labor market conditions, rising real wages and buoyant consumer confidence. With no end in sight for the economic upswing, the labor market is bound to see further improvements.

Net exports will continue to buttress the economic upswing in 2011, but only a marginally positive contribution can be expected from the external sector given the robust prospects for German imports in light of strengthening domestic demand.

Consumer prices accelerated sharply in early 2011 as rising energy and raw material prices fuelled pricing pressures. In addition, recovering domestic demand is pushing up core inflation. RGE expects harmonized consumer price inflation to reach 2.0% in 2011 before slowing to 1.8% in 2012 as second-round effects remain moderate.

Policy Implications: Fiscal Prudence Remains Key Priority

Fiscal consolidation clearly remains the government’s priority rather than the long-promised implementation of tax cuts. However, tax relief for households could help rebalance the German economy and provide assistance to troubled periphery economies by boosting German domestic demand. From Germany’s perspective, however, the stability of the eurozone as a whole arguably rests on the anchoring role of German fiscal prudence.

Upside Risks

  • The economic recovery in key trading partners accelerates, increasing German export growth.
  • The government implements tax cuts to boost private consumption.
  • Rising real incomes and favorable financing conditions trigger a housing boom.

Downside Risks

  • Global demand growth experiences an adverse shock.
  • Rising energy prices weigh on consumers’ purchasing power and firms’ profit margins.
  • Firms revise down investment plans as the export outlook becomes less certain.

Figure 1: Quarterly GDP (€ billions) vs. Contributions to Growth (percentage points)

Source: ECB

Figure 2: Unemployment Rate vs. Vacancies/Unemployed

Source: Bundesbank

Figure 3: HICP (y/y) vs. Core HICP (y/y)

Source: ECB

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