German economy temporarily losing momentum

Press Release of September 13, 2016

DIW Berlin short-term economic forecast: German GDP will increase by 1.9 percent in 2016, 1.0 percent in 2017, and 1.6 percent in 2018 – Brexit decision temporarily hindering growth – unemployment continues to fall, but wage increases are also slowing down – public budgets will end all three years with surpluses

According to the latest economic forecast from the German Institute for Economic Research (DIW Berlin), a temporary slow-down is expected for the German economy. Although this year’s GDP is expected to increase by 1.9 percent due to a surprisingly strong start into the year the consequences of June’s Brexit decision are likely to be felt during the winter months, thus dampening Germany’s economic growth. This also contributes to a lower growth rate for 2017: estimates put this figure now at 1.0 percent. As well, 2017 will have three fewer working days than 2016 – and this alone will dampen growth by four-tenths of a percentage point.

IN SHORT

Marcel Fratzscher (President of DIW Berlin): “The German economy will probably take a blow in the coming year. The Brexit vote has created significant uncertainty, causing many companies to hold back with investment on a global scale, and this will have a double impact on Germany: for one, it will dampen the already weak business investment, and secondly, it will put a burden on German exports, which are heavily dependent on capital goods. As well, there is a widespread fear that the public authorities will use the high surpluses for election gifts instead of investing in infrastructure and education.”

Ferdinand Fichtner (Head of the Department of Forecasting and Economic Policy): “Growth in the euro area is expected to be only moderate. In addition to the Brexit decision, other factors are creating significant problems: these include the crisis in the Italian banking sector and the confusion surrounding the formation of a government in Spain, as well as a growing global trend toward protectionism, which will have a major impact on export-oriented German industries.”

Simon Junker (Deputy Head of the Department of Forecasting and Economic Policy): “Due to an unexpectedly strong start, economic output in Germany will increase by as much as 1.9 percent this year. Things aren’t looking so good for 2017, however: the Brexit decision is having a negative impact on foreign trade, and the slow-down of consumer spending – as well as the fact that the coming year has fewer working days – will impede growth. Though employment is on the rise, it is losing momentum somewhat.”

Kristina van Deuverden (Financial expert and Research Associate in the Department of Forecasting and Economic Policy): “Once again, public budgets will close the year with significant surpluses – in the coming years, however, the fiscal balance will be significantly lower. This partly reflects the economic cycle but social security funds are also slipping into the red due in part to the ageing population – a problem that will only worsen in the coming years.”  

The Brexit decision’s dampening effects on Germany’s foreign trade are expected to last until mid-2017. For one, the UK itself will be importing fewer products; as well, the uncertainty surrounding the future economic relationship between the UK and the EU is creating expenditure restraint and a lower demand for products “Made in Germany.” This is also why German companies are continuing to hold back when it comes to investment. The German economy is expected to return to a somewhat steeper growth path from mid-2017 onward, when the global economy will experience a gradual recovery. In 2018, average growth is expected to amount to 1.6 percent.

Euro area development slowing down

According to DIW Berlin’s forecast, the global economy should experience only moderate growth in the coming years: 3.2 in 2016, 3.5 in 2017, and just under four percent in 2018. Growth has stabilized in the major emerging countries, such as China, and the US economy is also picking up somewhat; nevertheless, the result of the Brexit referendum is clouding things with uncertainty. This is especially true in the UK and euro area: growth in key countries like Italy and France had already been losing significant momentum prior to the decision, and production has now stagnated. Pre-existing issues like the crisis in the Italian banking sector have shifted back into focus as a result of the Brexit decision, impacting financing conditions and thus investment in many different places. 

The risks for the forecast period are considerable: in addition to the consequences of the Brexit decision – which are difficult to predict – the forthcoming constitutional referendum in Italy and the problems surrounding the formation of a government in Spain are posing a threat to economic development. Moreover, many countries are still experiencing unfavorable situations with regard to their public budgets and banking sectors. Growing protectionism as well as the US presidential election in November could restrict global trade – and this would have a particularly strong impact on export-oriented Germany industries.

Employment growth in Germany continues

Germany’s domestic economy is currently doing well, and this will probably remain the case. The unemployment rate will drop from 6.1 percent in the current year to 5.8 percent in 2018; employment growth will remain strong, but will lose some momentum. This year, half a million new jobs are expected to be created, while in the next two years, this figure will amount to 350,000 per year. As was the case in 2015, the increase in the minimum wage at the beginning of 2017 will likely have no significant effects on employment. Private consumption will remain an important growth driver, albeit not to the same extent as in the past year. This is also because the wage bill is developing rather modestly and no further purchasing power gains are expected from changes in oil prices, since no further price declines are expected over the course of the forecast period. Construction remains robust and will continue in its upward trend due to low interest rates and a strong demand for residential properties. In contrast, corporate investment in machinery and equipment is likely to remain weak – stronger growth is expected in the longer term, when the global economy starts experiencing a more dynamic growth. 

Public budget surpluses on the decline

The total public budget will end 2016 as well as the following two years with surpluses, which will become noticeably smaller over time. The revenue will continue its strong increase this year – by 4.1 percent – primarily because income taxes are considerably higher. In the coming year, however – if the profits only experience a slight increase – the profit taxes decline slightly. Wage tax revenue will lose momentum in the long run, since the wage bill will only experience a moderate increase. On the other hand, social security contributions will develop strongly, partly because the cumulative contribution rate will increase in every year of the forecast period. Overall, total revenue should experience considerably less growth in the next two years than in 2016.

This also applies to expenditures. This year’s dynamic is relatively high: more migrants are being granted refugee status and will thus be receiving higher benefits than they were during the approval process, pensions grew significantly over the course of the year, and child benefits were increased. In the coming years as well, transfer expenditures will increase considerably: at the beginning of 2017, the standard rates for Arbeitslosengeld II (unemployment benefits for long term unemployed) will be raised substantially; funding will be provided for integration measures; pension payments will continue to increase; and pension increases will become noticeable. Taken together, social securities will reach a deficit from next year onward, partly because corresponding expenditures are rapidly increasing as the population ages. Overall, the government’s fiscal balance should amount to 27 billion euros in 2016, 15 billion euros in 2017, and 16 billion euros in 2018 – that is, there will be clear surpluses.

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