The decline of Germany’s industrial leadership in automobiles and capital goods, and the resulting rebalancing of its economy, is a long-term process that will pose a structural constraint on the European powerhouse for years to come.
But within this structural process, the economic cycle continues to operate. For much of the past two years, a cyclical industrial decline coupled with a relative structural decline, combined with falling consumer confidence and the impact of monetary tightening on the construction sector, has brought German economic growth to a virtual halt.
Now, while Europe’s attention is focused on the sound and fury of French politics, the conditions for a cyclical recovery in Germany are gradually falling into place.
Germany’s 0.2% quarter-on-quarter growth in the first quarter of 2024 left the country’s real GDP at the same level as two years earlier in the first quarter of 2022.
This quarterly growth largely reflects the positive contribution of construction, which added 0.2 points to real GDP. However, the contribution was more likely to reflect a mild winter in Germany, which favored construction work, rather than the end of a two-year downturn in the sector.
Property is weak…
Although construction activity rebounded in the first quarter, new construction orders fell 17%. And unlike most European countries, where property prices have begun to stabilize or even recover, prices in Germany continue to fall. This suggests that weak demand will put pressure on German construction until the end of 2024.
The ECB’s rate cut cycle, which began last month, will help revive credit demand, which should be good news for the construction sector. However, the rate cuts are just beginning. Demand for loans is unlikely to increase until the end of 2024, and a significant impact on construction is not likely to occur until 2025.
…but production is growing
But while it would be premature to expect steady construction growth until 2025, German manufacturing appears to have bottomed out and is poised for a cyclical recovery.
The inventory cycle turns positive and lower energy prices allow for increased production in energy-intensive sectors. As a result, after experiencing a slowdown for most of 2023, German production has accelerated over the past three months. In April, production was still 3.6% below early 2023 levels, but up 1.3% from the February 2024 low.
Leading indicators point to further improvement in the future. IFO Business climate index Manufacturing business expectations have been rising since early 2024 and are now approaching the survey’s long-term median. Also encouraging is Sweden’s manufacturing output, which tends to outpace Germany’s by six months.
Risks remain
Admittedly, Germany’s nascent industrial recovery faces many risks. External demand could be hit by a slowing US economy. China’s retaliatory trade tariffs could hurt exports, and the macroeconomic impact of the French election remains uncertain.
But amid these risks, German consumers may begin to regain their confidence. Real wages—compensation per worker deflated by the consumer price index—rose for three straight quarters through the first quarter of 2024.
That lifted real compensation per worker to three points below the pre-pandemic baseline from a low of six below in the second quarter of 2023. The new wage agreements keep nominal wage growth at 4-5%, while inflation is likely to hover around 2-5%. 3%, this recovery in real purchasing power looks set to continue.
Consumers may return
The caveat is that with workers still worse off than before the crisis, it is unclear how many more quarters of real income growth it will take to restore consumers’ willingness to spend.
The good news is that surveys show consumer sentiment is starting to revive. After a sharp fall in energy prices at the end of 2022 to three standard deviations below the long-term average, German consumer confidence has now recovered and is just below the long-term average in May. Thus, consumption growth in the second half of 2024 looks more likely.
In conclusion, the German economy is not expected to return to strong growth over the next few quarters. However, the conditions for a cyclical rise are gradually emerging. This will be felt first in domestic consumer demand, then in industrial production and finally in construction – and this should last until 2025.
Cedric Gemel is an analyst for Europe at the company Gavekal. This article was originally published by Gavekal and republished with permission.
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