IHS Global: German GDP growth rests entirely on exports in second quarter as investment setback offsets moderate consumption
Frankfurt/Main (24.8.16) – Component data now released for the second quarter of 2016 confirms – as already shown by flash data released by the Federal Statistics Office (FSO) on 12 August – that German real GDP increased 0.4% quarter-on-quarter (q/q). While this is clearly weaker than the previous quarter’s exceptional 0.7% q/q, it exceeds the 0.3% average of the four quarters of 2015 and broadly matches the average growth pace of the period 2013-2015.
The second-quarter expenditure breakdown reveals that fixed investment declined even more strongly than had been expected on the basis of FSO indications on 12 August, importantly affecting equipment spending to an even greater extent than construction. Almost half of the larger-than-expected increase in fixed investment during the two preceding quarters has thus been unwound in Q2. At the same time, private consumption growth weakened to 0.2% q/q, its slowest pace of the last two years, and public consumption, although still posting a solid 0.6% q/q, grew at barely more than half the pace of the four previous quarters. The positive surprise among second-quarter results was that net exports contributed a sizeable 0.6 percentage points to overall GDP growth. Furthermore, this outcome owed at least as much to export growth staying robust as to imports reverting to more or less stagnation. The pattern just described implies that overall domestic demand growth at -0.2% q/q turned negative for the first time in a year. Even if the negative growth contribution from inventory destocking is taken into account (subtraction of 0.1 percentage point from quarterly GDP growth), the level of final domestic demand has retreated by 0.1% q/q in the second quarter. This contrasts sharply with average growth of 0.6% q/q observed since mid-2014.
Meanwhile, the year-on-year growth rate of overall GDP unadjusted for calendar factors has accelerated sharply from 1.5% to a five-year high of 3.1%, reflecting a major swing in working days (one day less in the first quarter, three days more in the second quarter compared with the year-ago quarter). The seasonally and calendar-adjusted series has actually weakened slightly from 1.8% to 1.7%. Nevertheless, underlying annualized GDP growth momentum in the German economy should be considered fairly stable in a range between 1.5% and 2% at present.
Looking at developments of the individual components in Q2 in more detail, the breakdown reveals the following about GDP growth contributions: Net exports added 0.6 percentage points from quarterly GDP growth, up from 0.3 points in Q1 and having subtracted 0.6 points on average in the two preceding quarters. Domestic demand net of inventories subtracted 0.1 point, in sharp contrast to the 0.8% average contribution in the two preceding quarters and the 0.6% average since mid-2014. The stock of inventories on their own dampened GDP growth by 0.1 percentage point, less than in Q1 (-0.3%) but nonetheless contrasting with the boosting impact during the two final quarters of 2015 (by 0.3 and 0.1 point, respectively). Thus, following a phase during the second half of 2015 in which companies started to rebuild stocks again, uncertainty and thus concerns about future demand appear to have been on the rise again during 2016 so far. Among the components of final domestic demand, private and public consumption each contributed 0.1 percentage point to quarterly GDP growth, whereas fixed investment subtracted 0.3 point, exactly unwinding the positive first-quarter contribution. Among fixed investment components, 0.2 points were each subtracted from GDP growth by investment in equipment and construction investment.
Private consumption at 0.2% q/q has slowed down further compared to an interim peak of 0.6% q/q in Q3 2015 and an average of 0.5% observed between mid-2014 and Q1 2016. It appears that a combination of heightened geopolitical uncertainty, Brexit fears, and an oil price rebound has temporarily provided a significant offset to an otherwise persistently favourable domestic environment for consumer spending. The latter includes healthy labour market and wage developments and an ongoing extremely soft monetary policy by the ECB that keeps interest rates near record lows and makes saving unattractive.
Government consumption growth decelerated from the previous quarter’s interim peak of 1.3% (and a 0.9% quarterly average since mid-2014) to 0.6% q/q. Nevertheless, this is still a more rapid growth pace relative to the historic norm, reflecting an ongoing loosening tendency of German fiscal policy (more spending on infrastructure and slightly reduced income taxation as of January) and the persisting 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 a budget surplus of 0.6% of GDP in 2015 and 1.2% during the first half of 2016, putting Germany in the favourable position of being able to provide fiscal stimuli without seriously risking renewed slippage into deficit during 2016-17.
Fixed investment declined 1.5% q/q, which contrasts markedly with increases of 1.7% q/q in each of the two previous quarters. Surprisingly, this was not only due to construction (-1.6% q/q), which had been expected due to a recoil effect of seasonally adjusted data to the unusually mild winter that had boosted first-quarter activity in the building sector. Investment in equipment even declined 2.4% q/q, thus unwinding most of the cumulative increase of 3.0% in Q4 2015 and Q1 2016. This shows that large global uncertainty (Middle East unrest and associated terrorism, politically destabilizing impact of refugee crisis, Brexit fears) has finally dampened the incentive to make long-term commitments based on expectations about future demand. Note that construction investment constitutes about 50% of overall fixed investment versus 32% for investment in equipment and 18% for “other investment” (software, R&D, licenses/patents, etc.), the latter being the only component that continued to grow (0.7% q/q). Latest leading indicator evidence regarding the building sector, such as the construction sub-index of the Ifo business climate survey (maintaining an upward trend) or the number of building permits (up 30% q/q in first-half 2016) suggest that construction sector activity will strengthen during the remainder of 2016. Separately, note that gross overall investment, i.e. including also inventories, has deteriorated from 0.1% q/q in Q1 to -2.1% q/q in Q2.
The positive contribution to GDP growth of 0.6% from external demand was the result of a still solid increase in exports of goods and services (1.2% q/q, following 1.6% in Q1) being accompanied by a slowdown of imports from growth of 1.3% q/q to -0.1% q/q. Exports thus held up surprisingly well in view of the increased level of global uncertainty, whereas weaker imports appear to reflect the setback to investment given diminished demand for imported intermediate goods for the production of investment goods. Indeed, revised data shows that imports already underperformed exports in the first quarter. Indeed, looking at the last two years since mid-2014, average export growth of 1.1% q/q was slightly stronger than import growth at 1.0% q/q. Furthermore, 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 now rebounded to an average of 54.6 in the period June-August. Therefore, even if imports recover again in the coming months as we expect due to rebounding domestic demand, exports will stay robust enough to prevent net exports from once again becoming a major drag on GDP growth during the second half of 2016.
The latest indications gleaned from key leading indicators remain fairly encouraging. Thus purchasing manager (PMI) data for the manufacturing sector and the Ifo business climate survey have been rebounding again since March, and the German service sector remains robust despite some modest slippage of the relevant PMI survey. The main factors underpinning the cautiously 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). Finally, 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 have to be housed in some way or another. These factors easily offset any dampening influence from the Brexit or still shaky emerging market demand.
Overall, IHS Global Insight has projected in its August forecast round that calendar adjusted year-average German GDP growth, following 1.5% in 2015, will accelerate to 1.8% in 2016 and 1.7% in 2017. Unadjusted for calendar factors (as used for official government forecasts), growth acceleration will be more modest from 1.7% in 2015 to 1.9% in 2016, followed by a slowdown to 1.5% in 2017. It should also be kept in mind that those sectors that display the highest growth momentum at present, namely services, construction, and government consumption, are underrepresented in the above-mentioned leading indicators. The underlying pace of economic growth is in a range of 1.5% to 2% present, and quarterly GDP growth should therefore fluctuate around 0.4% q/q during the next few quarters.
Timo Klein, Principal Economist | IHS Markit Economics