KfW Research raises growth forecast for Germany to 2.0% in 2017 and 2018

• Domestic demand remains main driver of growth
• Exports benefit from broad recovery in Europe and worldwide
• Corporate investment is picking up
• Unclear direction of US foreign and economic policy is main risk to the economy

The German economy looks back on a cyclically strong first half and is set for real growth of two per cent in 2017 as a whole. Besides very high levels of business confidence, the very broad base of the upturn now indicates that economic activity is picking up even more strongly than previously expected. Steady, high domestic demand is now increasingly coupled with external demand. This is reflected, for example, in companies’ growing export expectations and the increase in new orders from abroad – particularly from the euro area – that are filling their books. KfW Research has therefore raised its growth forecast for Germany to 2.0% for this year (previous forecast 1.6%). Economic output should grow by 2.0% next year as well (previous forecast: +1.6%). That would make 2018 the fifth consecutive year in which Germany grows faster than the long-term trend of around one and a half per cent.

This year and next year, the strongest impetus will again come from domestic demand. Spending on private consumption and residential construction should continue to point steadily upwards, not least as wages are likely to rise more strongly in response to increasing labour shortages. At the same time, exports are benefiting from a broad recovery in Europe and around the world, and will remain on an upward trend.

So there are plenty of reasons to be upbeat about the economy – even though a portion of the significantly higher growth rate predicted by KfW Research for 2017 has technical reasons. As every year in August, the German Federal Statistical Office has revised the time series for the past four years on the basis of underlying statistical data material now available for the first time. Roughly half the upward revision is due to this new official dataset. That leaves a ‘genuine’ 0.2 percentage points more optimism compared with the previous forecast of May.

‘Overall, the upswing rests on a very broad foundation. Exports should continue recovering on the back of an improving European and global economy. At the same time, strong domestic demand is generating high import momentum, leaving the growth contributions of external trade hovering around the zero line – a welcome development given Germany’s very high current account surplus’, said Dr Jörg Zeuner, Chief Economist of KfW Group.

As the upturn continues, aggregate production capacities will be increasingly utilised. According to the Ifo Institute, industrial capacity utilisation was already at 86.7% at the beginning of the third quarter, the highest level since spring of 2008. Corporate investment should therefore grow this year and next, especially since financing conditions will remain favourable despite the fact that borrowing costs are likely to rise somewhat in the future. ‘If Germany’s upswing is to continue beyond 2018, its capital stock will have to be expanded significantly’, said Dr Jörg Zeuner. ‘Otherwise the German economy would be at risk of gradually overheating.’

The main risks for Germany’s business cycle currently lie in the international sphere. Besides a possible renewed escalation of the North Korea conflict, introverted policy initiatives and protectionism – originating primarily from the USA – might gain ground. That would not just have negative effects on trade but would likely lead to less political cooperation as well. In addition, the Brexit negotiations could get out of hand and dim the outlook. Growth in Germany – and in Europe overall – might even turn out higher, especially in 2018, should the euro area succeed in making further structural progress.

KfW Business Cycle Compass