KfW Business Cycle Compass: German economy faces tough winter

• Supply bottlenecks, energy costs and fourth COVID wave will weigh on economic activity in the winter half-year
• Growth spurt from next spring
• KfW Research expects GDP growth of 4.4% in 2022 after 2.6% in 2021
• Euro area to grow 5.0% in 2021 and 4.2% in 2022
• Omicron variant remains unpredictable risk

In the third quarter, catch-up effects in contact-intensive services drove strong growth of 1.7% in Germany, defying persistent supply bottlenecks in manufacturing. But now the economy faces a tough winter. Steep energy price rises are reducing private purchasing power and increasing costs for businesses. At the same time, raw material bottlenecks and input shortages as well as disruptions to the global transport system remain widespread. With the start of the cold season, the fourth wave of COVID-19 infections is constantly climbing to new record levels amid insufficient vaccination rates. Containment measures and voluntary avoidance of social consumption for fear of infection are likely to put renewed pressure on the turnovers of many contact-intensive service businesses and stationary retailers. As a consequence, the economy will hardly move beyond stagnation in the 2021/2022 winter half-year that has now begun and may even slightly contract temporarily. But as material bottlenecks and the pandemic situation begin to ease more or less simultaneously, quarterly growth will then experience a vigorous surge from spring 2022. KfW Research expects the economy to grow by a much higher 4.4% (previous forecast: 4.2%) in the year ahead compared with 2.6% in 2021 (previous forecast: 3.0%; all rates price-adjusted).

“Part of the growth will shift to next year, and Germany’s gross domestic product will remain slightly below the pre-crisis level of the final quarter of 2019, by a good one per cent”, said Dr Fritzi Köhler-Geib, Chief Economist of KfW, at the press briefing on the 2022 economic outlook in Frankfurt. “But as the saying goes, all is not lost that is delayed. The German economy will grow above its pre-crisis level in the second quarter of 2022 – and it will do so quite quickly and noticeably once the inhibiting factors are resolved.”

The gap between demand and supply in manufacturing has widened continuously since mid-2020. Monthly new orders in manufacturing are currently almost 9% higher than in February 2020, the last month before the first coronavirus restrictions were imposed. By comparison, output is continuing to drop as a result of severe material bottlenecks and is now a good 11% below the pre-crisis level. The backlog of orders in manufacturing surveyed since January 2015 has therefore continuously grown to new record highs on a monthly basis already since early 2021. “As this enormous order backlog is reduced, a new growth surge is foreseeable in the course of 2022 as soon as the material shortages ease”, explained Köhler-Geib. “Once the fourth wave of the pandemic has been contained, consumption demand will also pick up again in the course of 2022, especially since private households have considerable excess savings which will also allow them to at least mitigate losses in purchasing power due to higher energy prices. From the first quarter of 2020 to the third quarter of 2021, the domestic savings ratio averaged 5.8 percentage points above the average of the previous ten years, which amounts to combined excess savings of EUR 208 billion or 6.2% of GDP of 2020.”

Quarter on quarter growth of gross domestic product (GDP) in the euro area was 2.2% in the third quarter of 2021, an even stronger rate than German GDP. The strong comeback of services, particularly hospitality and other contact-intensive sectors such as events, gave a strong boost to economic output in the euro area. At the same time, material bottlenecks weighed less on production than in Germany with its above-average share of manufacturing, including the automotive industry, which is particularly affected by the semiconductor shortage. The pre-crisis level is within reach for the euro area, with just 0.5% to go. The further recovery is being slowed down by an unhealthy combination of rapidly rising energy prices, persistent material bottlenecks and local waves of infection of varying intensity. In southern Europe the pandemic situation appears to be relatively steady and easily manageable thanks to high vaccination rates. By contrast, the dynamics of case numbers in Germany and other countries, especially in northern, central and eastern Europe, are high. Tightening restrictions here could lead to another slight contraction in social consumption over the winter. Quarterly growth in the euro area will therefore flatten in the short term before picking up again from next spring when the pandemic situation improves and material shortages decrease. On balance, KfW Research expects GDP growth of 5.0% for the euro area in 2021 (previous forecast: +4.7%; upward revision due to technical reasons as a result of updated historical GDP data by Eurostat). Economic growth should reach 4.2% in 2022 (previous forecast: 4.3%).

The coronavirus pandemic remains the primary risk to the economy, as clearly illustrated by the newly discovered virus variant Omicron. Köhler-Geib added: “Germany’s growth in 2022 could turn out between 2.5 and 4 percentage points lower than we are forecasting if tighter restrictions such as broad lockdowns need to be reimposed and, in the worst of cases, the recovery of the manufacturing sector is delayed further into the future by renewed global supply bottlenecks. But at the moment it is completely unclear whether Omicron is indeed more infectious or causes more serious disease. Another still unanswered question is whether existing vaccines provide significantly less protection from infection. “So it also remains unclear how likely these crisis scenarios are. What is also conceivable is that Omicron is more transmissible but causes much less severe disease than previous variants, which would end up bringing us a step closer to the end of the pandemic”, said Köhler-Geib.

The current KfW Business Cycle Compass is available at:

www.kfw.de/KfW-Konjunktur