KfW Business Cycle Compass - Brexit update: No revival in Germany or the euro area

• KfW Research reduces its growth forecast for Germany to 1.5% in 2016 and 1.2% in 2017
• Forecasts for EMU reduced to 1.3% in 2016 and 1.1% in 2017

The UK population's vote in favour of Brexit has scuppered the anticipated economic revival in Germany and the euro area. KfW Research has revised its economic forecasts for both the year in progress and 2017 downwards as a result of the referendum held on 23 June 2016. The growth of the German economy is now expected to be slightly slower than previously anticipated in 2016 (1.5%, previous forecast: 1.7%), and much weaker next year (1.2%, previous forecast: 1.8%). The growth rates for the euro area have been adjusted to 1.3% in 2016 and 1.1% in 2017 (previous forecasts: 1.6% and 1.8% respectively).

“The Brexit vote is an own goal for the UK, but the decision will also impact the growth of then Germany and in the euro area as a whole,” said Dr Jörg Zeuner, Chief Economist at KfW Group. In addition to the economic uncertainty which is due to uncerainty regarding its future relationship with the EU, the UK is suffering of political uncertainty. “Some of the parties are having to restructure themselves, and it is not even certain that the UK will continue to exist in its present form,” Zeuner said. According to Zeuner, banks in particular are reconsidering their decisions on where to locate. He does not believe that the devaluation of the pound will be an effective stabilising factor on account of the relatively small size of the country's export sector. “Even monetary stimulation will not be able to prevent the UK's economy from losing a lot of steam in the second half of the year,” Zeuner predicted.

Exports and corporate investment in particular are likely to be weaker in Germany. The UK is an important sales market for the German automotive industry, but also for its chemicals and pharmaceuticals companies. Export growth will slow considerably, not only because exports to the UK will be lower but also because the UK's vote will weaken the economies of other trading partners. Companies will withhold investment in light of the reduced prospects for sales coupled with the threat of a long period of uncertainty regarding Germany's future relationship with its third most important export market. “However, the German labour market and domestic demand remain consistently positive, and are taking the edge off the external headwind. The German economy will be able to more or less achieve its potential growth rate this year and next, but not exceed it as previously thought,” said Zeuner.

The UK's decision to leave the EU will also come as a setback to the recovery of the euro area. The direct impact is likely to be limited since foreign trade is less important to the euro area as a whole than it is to Germany. However, the raised level of uncertainty is having a particular impact on those economies in the euro area that are still struggling with the after effects of the financial crisis. “Brexit is impacting domestic demand in the euro area, which is still fragile. The weakness of the banking sector, in Italy in particular, is making new lending difficult and is likely to further weaken demand in the economy as a whole,” said Zeuner. “I expect growth in the euro area to be slowed temporarily, but no economic collapse on the scale of the 2008/2009 financial crisis or the 2012 euro crisis”.

The KfW Business Cycle Compass - Brexit update can be downloaded from

www.kfw.de/konjunkturkompass.