KfW Research expects tangible economic upturn after weak spring

• KfW reaffirms its economic growth forecast for Germany: 1.7% for 2016 and 1.8% for 2017
• Domestic demand will remain sound, exports and corporate investment will pick up
• Brexit and unexpected setbacks in the global economy are key downward risks

After the strong start to the year with first-quarter growth of 0.7%, the German economy is likely to slow during the spring before picking up momentum again from the summer. KfW Research expects real growth of gross domestic product (GDP) of 1.7% for the year, reaffirming its forecast of February. Domestic demand in Germany will remain on a solid growth path and, with a tailwind from the global economy, will provide growth above the long-term trend next year as well. KfW Research reiterates its 1.8% GDP growth forecast for Germany in 2017.

Favourable weather conditions in the strong first quarter of 2016 overstated the fundamental economic trend. The unusually warm winter allowed the construction sector to execute contracts well beyond the usual seasonal volume, as reflected in the very strong revival of construction investment. As they were brought forward earlier as scheduled, these construction projects are now lacking in the ongoing second quarter, generating a countermovement in the same order of magnitude. In addition, industrial production and retail turnover start the spring from a comparatively low basis after significant monthly declines in March. As a result, the German economy will probably grow by only a quarter of a percent overall in the second quarter. But KfW Research expects momentum to pick up noticeably already in the second half of the year. Average quarterly growth rates of a good one half of a percent are possible up to the end of 2017.

‘All ingredients for Germany’s solid upswing to continue are there. Consistently reliable domestic demand will gradually combine with a brighter external environment’, said Dr Jörg Zeuner, Chief Economist of KfW Group.

On the domestic front, private consumption and residential construction will continue to benefit from the good situation on the labour market, rising real incomes and low interest rates. Moreover, fiscal policy has an expansive effect, for example through income tax relief, pension increases, the planned expansion of government investment and higher public consumption expenditure caused by the refugee influx, among other factors. Last year’s highest government surplus in more than four decades makes a roughly balanced national budget achievable this year and in the years ahead – in spite of these tax cuts and increased expenditure.

At the same time, the pace of global growth will probably move up a gear. The picture of the developing and emerging market economies is currently characterised by a weak Chinese economy and recession in Russia and Brazil. This obscures the fact that many smaller countries are already recovering again this year. KfW Research expects the heavyweights to at least stabilise in 2017 and global economic growth to pick up pace then as well. This will benefit German exporters and boost corporate investments as capacity utilisation increases.

But Zeuner added: ‘A necessary precondition for my economic optimism is that the British vote in favour of continuing UK membership of the European Union on 23 June. If there is a Brexit, not only do I anticipate that businesses will become extremely uneasy about the future relationship between Germany and its third most important export partner, which in itself would be poison for investment. I also do not rule out renewed distortions on global financial markets if that happens. Under these circumstances Germany’s real growth would be significantly lower than we forecast for 2016 and, in particular, for 2017.’ Further downward risks are unexpected setbacks in the global restructuring and recovery process of emerging market economies and re-emerging political controversy in Europe, for instance over the refugee influx and unfavourable developments in the reforming countries.

The current KfW Business Cycle Compass Germany is available for download at: www.kfw.de/konjunkturkompass