KfW Business Cycle Compass: Prospects for recovery this year remain positive despite second coronavirus wave

• Despite renewed lockdown, Germany’s GDP grew 0.1% in fourth quarter of 2020
• KfW expects 1.5% to 3% contraction in first quarter of 2021 owing to continued high infection rates and prolonged restrictions
• Vaccination progress, increasing relaxations and avoidance of a third wave will allow recovery in spring and growth spurt in summer
• Germany is expected to grow 3.3% in 2021 as a whole, and the euro area as much as 4.6%

The German economy maintained a steady course towards the end of last year despite the renewed lockdown and the resulting restrictions on business activity. While gross domestic product in the euro area fell 0.6% in the fourth quarter because of the pandemic, Germany recorded growth of 0.1%. Nevertheless, KfW Research expects a difficult start to the new year with a contraction in gross domestic product of -1.5% to -3% in the first quarter owing to continuing high rates of infection and the persistent lockdown. If the virus can be successfully contained and a third wave is avoided, Germany can still return to pre-crisis levels in the fourth quarter, with 3.3% growth for all of 2021. The euro area is expected to grow 4.6% but will presumably not return to pre-crisis levels until 2022.

“In autumn the strong recovery in the industrial sector easily offset the foreseeable declines in value added in the restricted services segments”, explained Dr Fritzi Köhler-Geib, Chief Economist of KfW Group. “But since the current winter lockdown is now significantly longer than the first one last spring, and momentum in the industrial sector will probably weaken slightly, we expect a difficult start to the year 2021, with negative growth of -1.5% to -3%. To be sure, new infections have fallen continuously since mid-January, but the decline has recently stalled. The likely cause is the growing spread of the more contagious UK variant B.1.1.7, which in the worst of cases may even trigger a third wave. That and the sluggish vaccination rollout call for a cautious relaxation strategy.”

The outlook is brighter for the further course of the year. Rising immunisation rates will allow relaxations again in the spring, for example in hospitality, which will contribute to a recovery in services in the second quarter. From the third quarter it is likely that the economically relevant restrictions will be largely lifted, triggering a further growth surge. With expected growth of 3.3% in all of 2021 (previous forecast of November 2020: +4.0%), the pre-crisis level will be reached after two years, that is, in the fourth quarter of 2021. A similar growth rate of 3.4% is expected for 2022 (initial forecast).

The euro area can be expected to recover at a similarly vigorous pace as Germany, although its gross domestic product is not expected to return to the pre-crisis level before early 2022. To be sure, the euro area is set to grow 4.6% in 2021, which is a higher rate than Germany (initial forecast: +5.1%). But it will take longer to make up for the much stronger pandemic-induced drop of 6.8% in 2020 (Germany: -5.0%). Tourism in particular, which is an important sector in several countries, will recover more slowly than other areas of the economy.

Köhler-Geib: “The coronavirus remains the greatest risk to the economy for now. With multiple factors ranging from virus mutations through containment measures to progress in the vaccine rollout, the pandemic situation is evolving very dynamically, directly influencing the prospects for economic recovery as well as the continuing significant downside risks.”

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