German GDP growth slows slightly in late 2017, weak domestic momentum not fully compensated by net exports

Frankfurt/Main (14.2.18) – Based on “flash” data released by the Federal Statistics Office (FSO), German real GDP increased 0.6% quarter-on-quarter (q/q) during the fourth quarter of 2017, down from 0.7% q/q in Q3 (revised down from 0.8%) and an average of 0.8% q/q in the first half of 2017. Fourth-quarter headline growth matches our expectation (and that of the market consensus), formed after the release of preliminary full-year data on 11 January. The downward revision to the third quarter of 2017 has curtailed the overhang effect for 2018 a little, but it is worth noting that average growth in 2018 would nonetheless still be 1.0% even if (hypothetically) quarterly growth were zero throughout the current year. We are assuming that quarterly growth will average roughly 0.7% during the four quarters of 2018 (similar to 2017), based on persistently encouraging signals from key leading indicators. Thus we are maintaining the forecast of 2.8% GDP growth in 2018 that we already foresaw in our January forecast round. Average quarterly growth of 0.7% is almost twice as strong as the 0.4% average recorded during the period 2013-2016.

The FSO highlights that external trade boosted fourth-quarter GDP growth, as in the previous quarter. This apparently owes predominantly to exports picking up even further, despite them having grown at an average pace of 1.4% q/q in the four preceding quarters already. The wording suggests to us that net exports on their own boosted quarterly GDP growth by around 0.6 percentage points. This would mean that domestic demand was broadly flat in the final quarter of 2017. Based on FSO comments in the press release, it indeed seems that private consumption and fixed investment were little changed versus the previous quarter and that public consumption grew only modestly. The FSO do not make any statements about changes in inventories, but we estimate they had a slight dampening impact. Overall, final domestic demand (excluding changes in inventories) probably grew just marginally, hardly improving on third-quarter stagnation. This contrasts sharply with quarterly growth of around 1.0% during each of the first two quarters of 2017. Nevertheless, based on the calendar and seasonally adjusted series, the year-on-year rate for total real GDP has increased from 2.7% to 2.9%. This is the strongest pace of the last six years. Unadjusted for calendar effects, fourth-quarter annual growth only increased from 2.2% to 2.3% y/y as differences in the number of working days continue to restrain.

Today’s “flash” release for the fourth quarter as usual encompassed only data for the overall GDP aggregate and not the individual components. The latter will only be made available on 23 February. Looking at the qualitative guidance provided by the FSO a little more closely, it seems clear that private consumption remained flat, broadly repeating developments in the third quarter. Similarly, fixed investment was also close to stagnation, as a modest increase in equipment spending was roughly offset by a small decline in construction. This contrasts with the strong growth momentum of both private consumption and fixed investment during the first half of 2017, and it does surprise in view of the further gains observed for manufacturing PMI and Ifo leading indicators during the second half of last year that had seemed to signal no major concerns about factors such as the difficult Brexit negotiations or potentially looming protectionist measures by the Trump administration in the US. Only public consumption achieved a moderate increase in the fourth quarter.

The likely near-stagnation of final domestic demand, i.e. net of inventories, during the second half of 2017 (down from a quarterly pace of 1.0% q/q in the first half) should not concern unduly. As mentioned before, consumer spending has probably only encountered a temporary dip linked to higher fuel and food prices. Underlying factors affecting both 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 refugee related expenditures and general political pressure to put the current budget surpluses to good use. In addition, building activity, while battling with capacity constraints, continues to be driven 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.

With regard to the external sector, monthly trade data had already indicated marked strengthening during the final months of 2017, although the degree of apparent outperformance of exports versus imports was not as clear. The available evidence now suggests that import values were driven by higher prices in particular, so that import growth in real terms was not as robust as export growth. During the four quarters between Q4 of 2016 and Q3 2017, exports already grew at a healthy annualized clip of nearly 6%. This appears to have accelerated to the 8-10% range in late 2017, reflecting the recent pick-up in global trade growth that seems undaunted by anti-globalization challenges posed by events such as Brexit and the Trump presidency. An important factor in this respect is that demand in the Eurozone economy has been accelerating successively, as fiscal consolidation related to the debt crisis no longer exerts a braking influence and as robust German domestic demand since 2014 has itself contributed via strengthening German imports. This underlines that imports are indirectly also benefiting the German economy via increased export potential (as second-round effects) and stimulus for the domestic economy – a net export contribution to GDP growth of for instance 0.2 percentage points is a different animal when this happens alongside export and import growth of roughly 6% each rather than only 3% each. Separately, the sizeable euro appreciation since May 2017 – from around USD1.07 to roughly USD1.23 lately – has not had much of a restraining effect on export growth, confirming historic evidence that global trade growth is much more important for German export potential than price competitiveness. In the near term, net exports should thus continue to contribute to overall growth in GDP.

Notwithstanding the setback for domestic demand during the second half of 2017, momentum should return now in early 2018. The labour market has shown even larger improvement than had been anticipated half a year ago, the refugee factor hardly becoming visible in the numbers.  Stable employment growth of around 1.5% y/y is keeping any job concerns of consumers at historically low levels, while still extremely low interest rates are keeping the savings propensity in check. With regard to investment in equipment, the PMI sub-index for manufacturing orders was at a near-eight-year peak in December 2017 and the Ifo business climate index has marked all-time highs (for post-1991 and thus post-reunification times) in November 2017 and in January. Building sector activity will continue to receive positive impulses from demographic influences and therefore not let up any time soon. Notwithstanding the oil price increase between mid-2017 and January – which has in fact partly corrected in recent weeks – oil prices remain low when compared with 2011-14. Furthermore, the ECB is continuing to be very cautious about unwinding its extremely soft monetary policy, especially in view of the euro appreciation of recent months, and German fiscal policy will 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 remain near 3% in the near term and only weaken gradually towards the 2% level in 2019.

Our forthcoming February round GDP growth forecasts will confirm the mid-January predictions of 2.8% for 2018 and 2.0% for 2019. This compares with 2.5% (calendar adjusted) in 2017. The anticipated slowdown in 2019 reflects that imports should do better relative to exports and that fixed investment will not be able to sustain the momentum that we expect for 2018. Factors behind these developments will be the stronger euro and rising interest rates, the latter possibly also enticing consumers to save more than in recent years.

– Best regards, Timo Klein