Germany stuck in recession
The leading indicators suggest a bottoming out for the German economy, but a rapid recovery seems unlikely. Not only this year but also the upcoming one is expected to be challenging. This is reflected in the red signal of the current economic indicator by Börsen-Zeitung and Kiel Economics for the years 2023 and 2024. The indicator, which is based on more than 50 expectation-based indicators, points out that the German economy is in a downturn phase as pronounced as during the global financial crisis of 2008/2009.
Economic indicator flashes "dark red"
The probability of Germany's gross domestic product (GDP) decreasing this year has now risen to over 90%, compared to 67% in the previous edition of the economic indicator in July. Economic researchers and institutions have recently revised their forecasts downward. The German government, like the Ifo Institute, expects a decline of 0.4% for 2023, which is at the optimistic end of predictions. Based on data from the International Monetary Fund (IMF), Germany is the only leading industrialized country expected to shrink this year, by 0.5%. The most pessimistic forecast lies at -0.6%, as indicated in the joint economic forecast.
A further decline of 0.6 percent
The probability of a recession in Germany for 2024 remains high at 70%, with a projected annual decrease of 0.6% in real gross domestic product (GDP), according to Carsten-Patrick Meier, Head of Kiel Economics, an offshoot of the Kiel Institute for the World Economy (IfW).
Meier emphasizes a broad-based stabilization in leading indicators, indicating a possible turnaround. In the manufacturing sector, the declining trend in new orders that began in early 2022 seems to have halted. However, these positive signals are primarily driven by countries outside the Eurozone, which are less affected by the domestic economic weakness.
Euro exchange rate dampens expectations
The business sentiment in key countries crucial for German exports is showing signs of stabilization, but a full recovery is not yet in sight. "The decline in export expectations among companies since spring is likely linked to the noticeable revaluation of the Euro since the beginning of the year," suggests Meier. Except for the COVID-19 year 2020, export expectations in September were the most negative since the 2008/2009 financial crisis. Although industrial business expectations have risen for two consecutive months, the increase is not substantial enough to alleviate the skepticism among businesses, a sentiment exacerbated by the Russian invasion of Ukraine.
"This assessment also applies, albeit to a lesser extent, to consumer sentiment," Meier explains. While the income expectations of private households and their willingness to make purchases have moved away from the lows reached almost exactly a year ago, they have remained at a low level since spring. "The significant increase in oil prices in September is likely to further dampen the widely anticipated recovery of available household incomes," he adds. All consumer indicators, whether from the EU Commission, the Retail Association (HDE), or the GfK, are recording values well below their long-term averages, remaining in the red zone. Whether the higher business expectations in the retail sector in September will put an end to the downward trend observed since the beginning of the year is questionable, notes Meier.
Unique situation in construction industry
The construction sector poses a unique situation according to the head of Kiel Economics: Despite challenging conditions for demand in construction services, its production has shown little signs of slowdown so far. That is because capital costs for builders have tripled since early 2022, due to the European Central Bank's interest rate hikes and significantly increased construction prices. "As a result, demand for new high-rise buildings has dramatically plummeted," says Meier.
He anticipates a decrease in permits by 40% to 45% in 2023 compared to 2021. The fact that demand for construction services, measured by construction contracts, does not drop even half as much as permits is also due to the stabilizing effect of public civil engineering contracts. Nonetheless, Meier points out that the main reason is the significant delays in numerous construction projects because of the shortages in materials and labor, which were funded under the favorable conditions prevailing until early 2022.
Backlog of order helps
"In the coming year, the decline in building permits is expected to lead to a further decrease in construction output and investments," anticipates the institute's director. Despite that, the significant drop in production is countered by the relatively well-filled order books of construction companies. The backlog of orders stands at 3.6 months, which is one month above the long-term average. "Nevertheless, the number of cancellations has been increasing, especially in the residential construction sector."
Cash holdings increase
Meier also observes a stabilization in cash holdings. As expenditures require liquid assets, businesses and households tend to increase their demand deposits more than the trend suggests when planning higher spending. However, if they anticipate slower expenditure growth, they increase demand deposits less than the trend or may even reduce them. Meier emphasizes the need to adjust demand deposits for the general price increase to obtain a meaningful economic signal. Adjusted for inflation, he calculates a decline of demand deposits for this year, which is likely to be around 1%. The necessary adjustment for the effects of changes in opportunity costs resulting from interest rate fluctuations has a more significant impact. Corrected by this effect, real demand deposits are expected to increase by approximately 3% – more than the previous year, indicating a stabilization. Nevertheless, as this is still "2 percentage points below the trend," the probability of a recession increases.