Following a minimal contraction in the first half of the year, the economic situation remains sluggish in the summer, as construction and manufacturing are grappling with weak demand. The high stock of orders, however, is likely to further stabilise production and significant wage increases along with easing inflationary pressure should revive consumption. KfW Research therefore expects growth to gradually pick up at the end of the year and in the course of 2024. While the German economy will shrink moderately in 2023 as a whole (-0.4%), it should grow by 0.8% in 2024. Inflation will likely drop from 6.3% in 2023 to 2.5% in 2024. Euro area inflation can be expected to develop similarly, but we expect the euro area to grow at a significantly higher rate than Germany, reaching 0.7% in 2023 and 1.0% in 2024.
Economics in Brief
After a years-long, low-interest-rate environment, the COVID-19 pandemic and the Ukraine war have led to rapidly rising inflation rates. In order to fight inflation, the Fed began to lift benchmark rates in March and the ECB in July 2022. In addition, the central banks first rolled back their asset purchase programmes after years of quantitative easing before taking the further step of unwinding their asset holdings. The calculations presented in our most recent publication provide a rough indication as to how large the effects of quantitative tightening on inflation and GDP in the euro area and the US are (and could be in future) and how many interest hikes they substitute. The calculations indicate that the central banks' current monetary policy may already be more clearly in restrictive territory than the benchmark interest rate alone suggests.
Germany is poised for an economic recovery with one foot on the brake. Supply shocks are dissipating but the dampening effects of monetary policy are increasingly showing results. KfW Research expects growth of -0.3% in Germany for 2023 as a whole, a virtual stagnation, followed by moderate growth of 1.0% in 2024. Euro area GDP is likely to grow 0.8% in 2023 and 1.1% in 2024. Inflation in both economies is set to drop significantly from around 6% this year and get close to the 2% target again in 2024.
An inflation shock, war-induced uncertainty, rising interest rates and a weak global economy are choking off economic growth for the time being. Germany is poised to slip into a moderate technical recession in the winter half of 2022/2023. GDP will just barely stagnate in 2023 and grow by 1.0% in 2024. Inflation will remain at a high 5.8% in 2023 and moderate to 2.1% in 2024. According to our ecological price tag for GDP, greenhouse gas emissions will decline, but the drop will be 6% and 7% below the 2023 and 2024 policy target. Euro area GDP will grow by 0.5% in 2023 and 1.2% in 2024. Inflation there will sit at 5.4% and 1.7%, respectively. Depending on the progression of the Russia-Ukraine war, significant forecast revisions may become necessary.
Since the end of 2021, the yield of Italian government bonds rose by more than 3 percentage points, turning the question about the sustainability of Italy's government debt into an explosive issue. This One Pager analyses different scenarios: While the surprisingly high inflation of 2022 still contributed to reducing the debt ratio, in the long term the fiscal burdens resulting from the interest rate reversal will predominate. For Italy, every basis point counts.
Dwindling purchasing power, enormous uncertainty, rising interest rates and a weak global economy are weighing on economic activity in Germany. After growing by 1.7% in 2022, GDP will contract by 1.0% in 2023. The very steep rises in energy prices due to the war are increasingly filtering through. Inflation will be a very high 8.8% in 2022 and only dip to 6.2% on average across the year 2023. Greenhouse gas emissions will decline, but the drop will be 6% and 5% below the policy target in 2022 and 2023, respectively, as shown by our new indicator, the Ecological Price Tag for GDP. The euro area economy will grow by 3.3% in 2022, and GDP will stagnate in 2023. Given the multiple crisis situation, upward and downward forecasting risks are significantly larger than usual.
Focus on Economics
The record inflation rates of the past months have put pressure on the European Central Bank (ECB) and the US Federal Reserve to combat the sharp price increases with a more restrictive monetary policy. Whereas the Fed began its monetary policy turnaround already in March, it was not until the Governing Council meeting of July 2022 that the ECB changed its course. This Focus explains the different pace of the monetary policy measures thus far adopted by the two central banks with the dissimilar economic and labour market developments after the pandemic. As the ECB has taken longer to change its course, the window for comprehensive rate hikes to fight inflation appears to be much smaller because of the impending economic slowdown in the euro area. The ECB is in a difficult position and it appears less clear whether it can steadily pursue its course.
The economic outlook has deteriorated further. After the catching-up movement in the services sector has been largely completed, economic headwinds now predominate. Both Germany and the euro area can be expected to see negative quarterly growth rates by the winter half-year at the latest. After growth of 1.4% in the current year, we expect Germany’s GDP to contract by 0.3% in 2023. A gas shortage would create a genuine recession in 2023 (-2.5%). Thanks to a strong first half, euro area GDP growth will still be a good 3.0% in 2022 but probably sit at 0.5% in 2023. Inflation will not trend downward until sometime in 2023. Inflation in Germany will stand at 8.4% in all of 2022 before dropping to around 5% in 2023. Euro area inflation rates can be expected to be on a similar level.
The war in Ukraine has dashed hopes of a vigorous economic rebound and is driving inflation. Germany’s GDP will grow by only 1.6% in 2022, with economic growth even falling to 1.2% in 2023. While the dampening effects of the pandemic are waning and the services sector is recovering somewhat over the spring and summer months, Russia’s war of aggression is prolonging global supply chain problems, driving up energy costs and putting pressure on purchasing power. Germany’s inflation rate will be a very high 6.3% in 2022 but will drop to 3.0% in 2023. The euro area is set to grow by 2.5% in 2022 and 1.3% in 2023; consumer prices there will increase by 6.4% in 2022 and 3.1% in 2023. Our new forecast is based on the assumption of persistently high energy prices but no natural gas embargo.
Following the significant setback in the autumn of 2021, the pandemic also put a damper on the economic start to the year. The very high infection rates have meant that a good one percent of the workforce has been absent from work on average during the first quarter, contributing to weak growth at best. After that, however, growth is likely to resume at a much faster pace because the planned lifting of most restrictions will give a boost to private consumption. Material bottlenecks will likely improve in the course of the year to a degree that allows manufacturing to generate strong growth as well. Very high energy prices are creating strong headwinds, however, reducing purchasing power and weighing on energy-intensive production. Overall, KfW Research expects growth of 3.2% in Germany in 2022, followed by 2.9% next year. We expect 3.6 and 2.7% for the euro area. Russia’s invasion of Ukraine constitutes a major risk to the economy.
Focus on Economics
The influence of a rising carbon price on the inflation rate is crucially determined by the amount of avoidance responses in favour of less carbon-intensive goods. The stronger the (intended) avoidance response to fossil price increases, the lower the general inflationary pressure. How inflation will evolve in the course of the climate transition therefore crucially depends on its implementation. Policymakers can contribute significantly to making the transition to a climate neutral economy succeed while maintaining a steady price level overall in the medium to long term, particularly by designing economic and climate policies consistently, efficiently and for the long run.
German GDP will grow by a much stronger 4.4% in 2022 compared with 2.6% in 2021. After stagnating in the winter as a result of supply chain bottlenecks and pandemic-induced losses in contact-intensive services segments, quarterly growth will really pick up steam again from the spring. Manufacturing orders are at record high levels and will generate a strong output increase in 2022 as soon as bottlenecks ease. And as the pandemic is contained, consumption will also gain momentum again, especially since households have built up considerable excess savings which will enable them to at least mitigate losses in purchasing power due to higher energy prices. The euro area is set to grow by 4.2% in 2022 after 5.0% in 2021.The pandemic remains the primary risk, as vividly illustrated by the newly detected Omicron virus variant.
Focus on Economics
In the coming years there will be a significant need for debt consolidation resulting from crisis-driven higher debt levels, while significant public investment will become necessary at the same time. It is therefore important to take a closer look at the structure and, above all, the efficiency of government expenditure. That means examining the relationship between the output achieved in pursuing the objectives of expenditure and the money spent. This paper provides input for reflection on this issue. We examine the efficiency of government expenditure in Germany in an international comparison on the basis of current indicators, focusing on the areas of education and infrastructure. Overall, Germany’s public sector so far appears to be quite efficient in both categories. Since the output is rather average, however, the efficiency primarily results from the comparatively low amounts spent on these areas. Remaining efficient even with higher expenditures will be a major challenge.
Focus on Economics
In the context of the Green Deal, the EU Commission is planning to introduce an import-side Carbon Border Adjustment Mechanism (CBAM) and presented a corresponding draft regulation in July 2021. Its implementation will need to take into consideration the legal framework, implications for trade policy and administrative feasibility. If the EU manages to skilfully take into account the expected impact patterns outside the union and minimise political risks, the CBAM can leverage its international orientation as a strength. Ideally, it would pave the way towards a globally coordinated climate policy.
Growth is back. Thanks to the at times marked fall in the number of infections, the economy recovered in the second quarter, with German GDP growing by 1.6% and euro area output even by 2.0%. The catch-up effect in the services sector and strong private consumption are set to generate strong growth in the current quarter that will continue at a more moderate pace in autumn. The Delta variant and, in particular, supply shortages are reducing upside potential, which is why we expect growth of only 3.0% in Germany in 2021. A statistical overhang and the backlog of industrial orders are set to generate a plus of 4.2% in 2022. Given the surprisingly strong first half of the year in other member states, we have revised our forecast for this year’s growth in the euro area upwards. We now expect 4.7%, followed by 4.3% in the coming year.
Focus on Economics
Inflation and interest rates in industrialised countries (ICs) have trended downward for a good 30 years now. Today they are well below their long-term average. Central banks and their low and negative interest rate policies are an important but by no means the sole driver of this development. Rather, demographic processes, the rise of China and advancing globalisation since the 1990s are likely to have been the main factors that have exerted downward pressure on price and interest levels. This means that even without the monetary policy responses to the crises of the past decade interest and inflation rates today are likely lower than as recently as in the 1990s, for example. Our study discusses the impact chains of these processes in greater detail and explains that longer-term upside risks to inflation and interest rates in ICs are likely to result primarily from the reversal of the former.
Vaccination progress has clearly picked up pace and the third infection wave has been contained. With the first steps towards a reopening, Germany’s GDP is set to grow again this quarter. Growth will presumably jump noticeably in the summer and GDP will surpass the pre-crisis level in autumn. Germany’s GDP will probably expand by 3.5% in 2021 as a whole. The growth rate for 2022 is predicted to be 4.0%, although this high rate will primarily result from an exceptionally high statistical overhang. Driven by catch-up growth, GDP in the euro area will likely grow by 4.5% in 2021 and 4.3% in 2022. The pandemic continues to pose particular downside risks. However, should the supply bottlenecks in the manufacturing sector be resolved quickly, growth might also turn out higher.
Focus on Economics
Around the world, government debt has grown dramatically in response to the coronavirus crisis. But how sustainable is the debt that has built up? This paper analyses the prospects for reducing government debt ratios using the examples of Germany and Italy. It focuses on longer-term developments from 2023, when both the recession and the immediate recovery phase will presumably have come to an end. On the basis of various scenarios, we demonstrate how crucial the relationship between interest rates and economic growth rates is for meeting the consolidation challenge. In the current environment of extremely low interest rates, Germany’s debt-to-GDP ratio could fall below the Maastricht threshold in the course of this decade already and even Italy could succeed in slowly reducing its debt ratio with only moderate budget surpluses. A structural increase in the interest-growth differential, on the other hand, would pose a great risk to Italy’s debt sustainability.
Continued high infection rates, the risk of more contagious virus mutations and the resulting extended restrictions will cause Germany’s economy to contract sharply in the first quarter of 2021. But with increasing progress in the rollout of vaccines and restrictions being eased first cautiously and then more broadly as the virus is successfully controlled and a third wave is avoided, a noticeable recovery will emerge in the spring and a growth spurt in the summer. Germany’s GDP is forecast to grow by 3.3% in 2021 and 3.4% in 2022. The pre-crisis level will be reached again in the fourth quarter of 2021. Driven by vigorous catch-up growth, GDP in the euro area is set to grow by 4.6% in 2021 and 4.0% in 2022. The euro area as a whole, however, will not return to the pre-crisis level yet in 2021.
In the summer months Germany and the euro area were able to offset a large part of the previous economic contraction. However, as a result of the renewed sharp rise in the number of new COVID-19 infections since the beginning of autumn and the restrictions that became necessary, the recovery will stop temporarily. A decline in economic output is to be expected for the winter half-year of 2020/2021. Based on the encouraging perspective that effective vaccines will soon be available, KfW Research forecasts that the return to public life and social activities will lead to a surge in growth from next spring. Germany is set to grow by 4.0% in 2021 and the euro area by as much as 5.1%, starting from a lower level.
The coronavirus pandemic has led to an economic slump of historic proportions in Germany and the euro area. The low point, however, was passed back in April. It was followed by a vigorous catch-up movement that translates into very high growth in the present quarter. However, headwinds are gathering strength.
KfW Research stands by its forecast that Germany’s gross domestic product will contract by around 6% this year, before growing again by 5% next year. Gross domestic product in the euro area is set to contract by around 8% overall in 2020. A severe second wave of infections remains the highest risk, although new restriction measures will likely end up being more targeted than in spring.
Focus von Economics
The European Central Bank (ECB) is currently reviewing its monetary policy strategy. The central element in this process is the inflation target - in an environment of significantly lower rates of inflation than at the time the current target of "below, but close to, 2%" was set. We consider it particularly sensible to make the target more flexible, which would also allow inflation rates below 2% to be tolerated. Such a more flexible target would be compatible with the fulfilment of the ECB's mandate, would take account of the current new reality of low inflation, would give the ECB greater room for manoeuvre and, in perspective, would also make it easier for it to exit from its unconventional measures.
The pandemic has hit Europe like a bolt of lightning. The recession is unprecedented in breadth and depth, with the German economy expected to contract by around 6% in 2020. However, in the absence of a second wave of infections, an initially strong and then faltering recovery should begin as early as the second half of the year, which will be reflected in a catch-up growth rate of 5% in 2021. Output will thus return to its pre-crisis level in autumn of 2021. Aggregate output loss will then be around EUR 300 billion.
In the euro area, the recession will likely be even deeper (2020: -7%; 2021: +6%), since the pandemic has hit the other large countries – France, Italy and Spain – particularly hard and the structural environment is unfavourable as well.
Economics in Brief
Trade conflicts, Brexit, sanctions, geopolitical confrontations and now the coronavirus outbreak: Difficult international conditions are putting constant pressure on global trade. This is not just afflicting Europe’s exporters but also causing a noticeable slowdown in economic activity in the euro area.
However, the weakness was not spread equally across all sales markets of European exports last year. Rather, the loss of momentum since 2017 has been mainly due to China and the dynamic Asian economies that are closely intertwined with that country. So in addition to the trade conflict, other factors such as the transition of the Chinese growth model, the accelerated expansion of e-mobility and the downswing in the global electronics cycle have probably also played a role in the region’s slowing demand for European goods.
From July to September, the euro area economy maintained the sluggish pace of growth of the previous quarter. This is no disappointment considering the decreasing sentiment indicators and temporary escalation of political risks. France and Spain in particular exhibited robust economic performance, while Italy and Germany – which is heavily affected by the industrial recession – expanded only marginally.
Some of the political headwind has also subsided of late. In particular, the hard Brexit which was still looming in the summer did not occur on 31 October, which prompted us to upgrade our forecast for the winter half year. KfW Research now expects the low but nonetheless clearly positive growth to continue in the current and next quarter, along with a gradual return to trend growth from spring. Economic output in the euro area should grow by 1.2% in all of 2019 and by 1.0% in 2020.
Going Digital – The Challenges Facing European SMEs
More than one in two European SMEs consider the use of new digital technologies necessary to secure their competitiveness. Many small and medium-sized enterprises have not yet made much progress here due to a number of digitalisation hurdles, including insufficient digital infrastructures and a lack of digital competency, both in the business itself and on the external labour market. This is shown in a joint study from KfW Research and the European promotional institutions Bpifrance, BGK, ICO and the British Business Bank, in which more than 2,500 small and medium-sized enterprises in Germany, France, Poland, Spain and the United Kingdom were surveyed. Although some SMEs anticipate that some tasks in their company may become obsolete as a result of digitalisation, most of them believe that the number of employees in their company will remain stable – or even grow.
Economics in Brief
Bulgaria has positioned itself to entering the Exchange Rate Mechanism II and ultimately to joining the euro. The EU country has long fulfilled the Maastricht convergence criteria. It also passed a recent ECB stress test which put the country's most important banks through their paces. But in order for its accession to the euro area to be crowned with success, Sofia still needs to make improvements in some areas.
Amid a contraction in overall economic output in Germany, the euro area’s largest economy, the monetary union as a whole nevertheless managed to achieve meagre growth of 0.2% on the previous quarter.
We are now more sceptical about the further outlook than in the spring. The most recent business surveys show that there is no end in sight to the industrial recession. The escalating trade conflicts and the UK government’s confrontational Brexit strategy are both taking their toll.
We therefore expect the economic weakness to continue until mid-2020 and have downgraded our growth forecast slightly to 1.0% for the current year and sharply to 0.7% for the coming year.
In the first quarter of this year the euro area economy grew 0.4%, twice the rate of the preceding quarter. The joy over this is likely to be short-lived, however. Adverse international conditions are weighing on the industrial sectors and the renewed escalation of trade tensions is hampering the trend reversal.
We therefore expect the growth rate to level off again in the current quarter and maintain our GDP forecast unchanged at 1.1% for 2019 and 1.5% for 2020.
The downward risks to the business cycle are substantial and have risen again lately. The likelihood of a hard Brexit, new turmoil surrounding Italy’s public finances, rising protectionism and sanctions is growing. This is fuelling concerns that the weakness, which has so far been restricted to the manufacturing sector, will spill over into the labour market and the aggregate economy.
In the course of 2018, economic performance in the monetary union slowed down significantly and the rapid deterioration in European business confidence at the start of the year is not good news. Even though one-off effects – such as the WLTP conversion – are subsiding, there are no signs of a vigorous recovery. Manufacturing, in particular, continues to suffer from the downturn in global activity and trade tensions.
KfW Research has therefore lowered its GDP forecast for 2019 to just 1.1%. The year 2020 should then see slightly more lively growth of 1.5%. However, our forecast is based on the assumption that none of the major downward risks materialises. In that case, a recession would probably be inevitable.