KfW Business Cycle Compass: Germany is on the long path out of the coronavirus slump

• KfW Research expects the German economy to contract by 6% and the euro area to even shrink by 7% in 2020
• After hitting lows in April, a sharp rebound is likely to be followed by a slower rate of recovery in the third quarter
• Monetary and fiscal policy are mitigating the impact of the crisis
• Downward risks predominate

The coronavirus pandemic has hit Europe with full force since the beginning of March and radically worsened the economic outlook. Like all states of the euro area, Germany responded with strict containment measures that paralysed much of public life and business activity. The country’s economic output is likely to have been 20-25% below pre-crisis levels for several weeks, and in the euro area even by around 30%. Provided a second wave of infections can be prevented, economic activity should have bottomed out in April. With the lifting of many restrictions, it should at least partly normalise by summer, and that will almost automatically lead to very high growth in the third quarter. KfW Research predicts that for all of 2020 Germany’s GDP will contract by 6%. The other large euro states (France, Italy and Spain) are more severely affected by the coronavirus and are therefore likely to experience a much deeper recession than Germany, so that the euro area’s total economic output will shrink by 7% this year. For 2021 KfW Research predicts +5% growth in Germany and +6% in the euro area.

In spite of the gradual lifting of restrictions, the return to public life and economic activity will be a slow process in Germany and Europe and will probably remain so until a vaccine or very effective treatment is available. In particular, for fear of contagion and because of great economic uncertainty, consumers will exercise considerable restraint until rapid tests are available, infection chains can be tracked and widespread behaviour protocols for a range of economic sectors are in place. In addition, necessary safety measures continue to limit capacity in some sectors, and industrial production is likely to remain disrupted for some time to come because of disruptions to value chains and collapsing demand. And as long as the crisis has not been sustainably overcome by all major trading partners, many investments will likely not materialise owing to the enormous uncertainty.

“The coronavirus crisis has hit Germany like a bolt of lightning”, said Dr Fritzi Köhler-Geib, Chief Economist of KfW. “The rebound is likely to begin already in the second half of the year, but we probably won’t return to pre-crisis levels until autumn of 2021. The cost of the crisis in lost economic output will then be roughly EUR 300 billion.” That is roughly equal to the gross domestic product of Denmark.

“Without the swift fiscal and monetary policy response, the recession would be even more devastating”, said Köhler-Geib. “Grants and bridging loans as well as a range of adjustments to banking regulation as well as rental and insolvency legislation are helping the business community. The short-time work allowance is reducing fixed costs, protecting jobs and bolstering domestic demand. A large portion of businesses is likely to come out of the crisis with bruises, but they will survive. However, all measures can only bridge the lockdown situation. We must now find ways to protect both lives and livelihoods by conducting rapid tests, tracking infection chains and putting in place behaviour protocols.”

However, downward risks prevail in the current economic forecasts of KfW Research. Most obvious is the threat of a second wave of infections. But economic second-round effects are also possible if sovereign debt or banking crises should emerge in Europe as a result of rising debt levels. That makes the stabilisation function of monetary policy important, which, however, has been jeopardised by the ruling of Germany’s Federal Constitutional Court. Positive surprises for the economy are conceivable, for example in the form of fast medical advances.

The current KfW Business Cycle Compass is available at
www.kfw.de/konjunkturkompass