KfW Business Cycle Compass: German economy exhibits solid growth

• Outlook for domestic economy still positive, yet lack of momentum in corporate investment
• Weaker export growth in second half of year due to Brexit vote
• KfW Research expects economic growth of 1.8% in 2016; 1.3% in 2017

After a very good first six months, the German economy will begin the second half of 2016 in a robust condition. Due to growth that exceeded expectations in the second quarter (+0.4% over the previous quarter), KfW Research revised the economic forecast slightly upwards to 1.8%, after lowering it to 1.5% following the Brexit vote. Economic growth of 1.3% is expected in 2017 (preliminary forecast: 1.2%).

In the second quarter of 2016, the growth rate of the German economy was, in fact, slightly less, but the decline was lower than expected after the weather-related temporary boom in construction during winter. It was still enough, despite clearly declining industrial production, for slightly above-average growth compared to the long-term trend, which was supported by both consumption and positive net exports. However, the sharp drop in investment in equipment (-2.4%) is a negative aspect that shows the structural weakness of investment activity has not been overcome. The mood of the domestic economy continues to be positive mid-year, as signaled by the current ifo Business Climate in July and the Purchasing Managers' Index (PMI) for August.

"The robust state of the German economy indicates that the domestic economy will remain healthy," says Dr Jörg Zeuner, Chief Economist at KfW Group. Employment continues to rise, supporting private consumption and residential construction. The state is likely to expand its consumer spending as a result of refugee migration, sufficient flexibility is availability in public budgets to support this. "All in all, the German economy currently has a strong tailwind – without Brexit, a sharp rise would have been possible," states Zeuner.

The British decision against remaining in the European Union is, however, likely to curb the rate of growth. According to KfW Research's forecast, the United Kingdom, an important market for German companies, will achieve economic growth of less than half a percent in the coming year. This will act as a brake on the German economy via exports. Growth in German exports is expected to dip, despite gradual improvements in the economic situation of developing and emerging countries. All the more so, as the upswing slowed down in the other eurozone countries and another major trading partner, Turkey, is experiencing a period of increased political uncertainty following the attempted coup. The weaker export performance also limits the potential for upward movement in corporate investments.

"The pace of economic growth in Germany will pick up again after the immediate effects of the Brexit fade away in the coming year. Nevertheless, at 1.3%, the annual growth rate for 2017 is significantly lower than expected," says Zeuner. This is due to a calendar effect: "In the coming year, employees can look forward to three additional days off work. But that will cause lower economic growth. Approximately four-fifths of the drop in growth rates is attributable to this."

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