German GDP growth softens in Q3 as domestic demand rebound cannot fully compensate for deteriorating net exports
Frankfurt/Main (27.11.16) – Component data now released for the third quarter of 2016 confirms – as already shown by flash data released by the Federal Statistics Office (FSO) on 15 November – that German real GDP increased 0.2% quarter-on-quarter (q/q). This is weaker than the previous quarter’s pace of 0.4% and even 0.7% in the first quarter of 2016. The average growth pace during the period 2013-2015 has been slightly less than 0.4% q/q. The third-quarter expenditure breakdown matches expectations formed on the basis of the FSO indications in their press release of 15 November.
Thus domestic demand rebounded from slight slippage in Q2 (-0.1% q/q) to 0.5% q/q whereas net exports swung from a positive contribution of 0.5 percentage points to overall GDP growth to a negative one of 0.3 points. The latter was almost exclusively due to deteriorating exports, while import growth was little changed just above the zero line. Among domestic demand components, private consumption growth strengthened after a weak phase in the second quarter and public consumption remained very robust at around 1.0% q/q. Investment only stagnated, but this represents improvement following its second-quarter dip. Equipment spending still slipped modestly while construction investment returned to positive growth territory. Changes in inventories marginally supported GDP growth, so that final domestic demand grew by 0.4% q/q. This broadly matches the average pace observed since the start of 2014.
Meanwhile, the year-on-year growth rate of overall GDP unadjusted for calendar factors has decelerated sharply from a five-year high of 3.1% to 1.5%, the same rate as in Q1. This only reflects a major swing in working days, however (three days more compared to the year-ago quarter in Q2, slight negative calendar effect in Q3). There were no revisions of any significance to the quarterly growth rates of the first and second quarters of 2016, and data prior to the current year has been left untouched (as is the normal procedure for the November release). The seasonally and calendar-adjusted series shows an unchanged annual rate of 1.7%. 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 Q3 in more detail, the breakdown reveals the following about GDP growth contributions: Net exports subtracted 0.3 percentage points from quarterly GDP growth, contrasting with a positive contribution of 0.5 points in Q2. Domestic demand net of inventories added 0.4 points, thus rebounding from virtual stagnation in Q2 but still only half the growth pace of the two quarters saddling the turn of the year 2015/16. The stock of inventories on their own added 0.04 percentage point to GDP growth, representing an improvement compared to subtractions of 0.2% each in the two preceding quarters. Notwithstanding this relative improvement, companies remain hesitant to rebuild stocks again, which is understandable due to the fairly high levels of geopolitical uncertainty in these times – it is not easy to be confident about future demand levels. Among the components of final domestic demand, private and public consumption each contributed 0.2 percentage point to quarterly GDP growth, whereas fixed investment was neutral. Based on data rounded to one decimal, the latter also applied to its main components, i.e. investment in equipment and construction investment.
Private consumption growth at 0.4% q/q was twice as strong as in the second quarter. Although this remains slightly weaker than the 0.5% average seen between mid-2014 and mid-2016, it is fair to say this represents normalization in view of an overall still quite favourable domestic environment for consumer spending. Healthy labour market and wage developments and an ongoing extremely soft monetary policy by the ECB (keeping interest rates near record lows and thus rendering saving unattractive) are being offset to some extent by the recent upturn in headline inflation.
Government consumption growth decelerated from 1.2% to 1.0% q/q. However, it is important to note that the second-quarter outcome has been revised up sharply from an initial 0.6% q/q and that the latest growth pace still slightly exceeds the 0.9% quarterly average seen since mid-2014. When compared with a quarterly average of less than 0.3% q/q during 2010-14, this is quite high, reflecting an ongoing loosening tendency of German fiscal policy (more spending on infrastructure and slightly reduced income taxation) 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 a similar outcome is anticipated for 2016 and 2017. Germany therefore 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 stagnated in Q3, following a dip of 1.6% q/q in the previous quarter but increases of 1.6% q/q in both the final quarter of 2015 and the first quarter of 2016. Construction investment recovered from -1.9% q/q to 0.3% q/q, essentially normalizing after a second quarter hit by the recoil effect linked to an unusually mild winter that had boosted first-quarter activity. Investment in equipment still declined at -0.6% q/q. Although this was also a significant improvement compared to the previous quarter’s decline by 2.3% q/q, a return to the healthy increase seen in Q4 2015 and Q1 2016 (cumulatively by almost 3%) is still outstanding. This demonstrates that large global uncertainty (Middle East unrest and associated terrorism, politically destabilizing impact of refugee crisis, Brexit fears) currently dampens the incentive to make long-term commitments based on expectations about future demand. Note that construction investment constitutes 49% of overall fixed investment versus 33% for investment in equipment and 18% for “other investment” (software, R&D, licenses/patents, etc.). The latter component grew 0.6% q/q in Q3. Latest leading indicator evidence regarding the building sector, such as the construction sub-index of the Ifo business climate survey (moving from one record to the next) or the number of building permits (up 24% y/y during January-September 2016) suggest that construction sector activity remains on a strengthening trajectory as 2017 approaches. Separately, note that gross overall investment, i.e. including also inventories, has recovered from -2.4% q/q in Q2 to 0.2% q/q in Q3.
The negative contribution to GDP growth of -0.3% from external demand was almost entirely the result of deteriorating exports of goods and services (-0.4% q/q, following 1.2% in Q2). Import growth edged up from 0.1% to 0.2% q/q. Exports have thus finally been impacted to some extent by the increased level of global uncertainty (including the UK’s Brexit vote), while imports at the same time remain unusually subdued despite robust domestic demand that should also support purchases of intermediate goods from abroad for the production of investment goods. Looking back at the period since mid-2014, exports and imports now both show average growth of 0.9% q/q. 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 recovered to the region of 55.0 since June. This argues for exports returning to positive growth again already in Q4, which means that even in the event of renewed strengthening of import demand we expect net exports to remain roughly neutral for GDP growth in the coming quarters.
The latest indications gleaned from key leading indicators remain encouraging. Thus purchasing manager (PMI) data and the Ifo business climate survey have been rebounding again since March, also overcoming an interim correction during the summer. 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 also due to the large number of immigrants that require housing. These factors offset any future dampening influence from the Brexit or still shaky demand in many emerging markets.
Overall, IHS Global Insight has projected in its November 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 will rather move sideways, as a pace of 1.7% in 2015 should be followed by 1.9% in 2016 but 1.5% in 2017 as negative calendar factors bite. It should 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 is expected to increase markedly from a sub-average 0.2% in Q3 to at least 0.5% q/q in Q4.
Timo Klein