KfW Business Cycle Compass: Upswing with many risks

• Year gets off to bad start due to Omicron wave
• KfW Research expects 3.2 % GDP growth in 2022 and 2.9 % in 2023 for Germany, 3.6 % in 2022 and 2.7 % in 2023 for the euro area
• Economic risks include the escalation of the Russia-Ukraine conflict, continuing high inflation, the pandemic and persistent supply chain problems

After Germany’s economic output contracted in the fourth quarter of 2021 by 0.3 % on the previous quarter, mainly as a result of the Delta wave and high numbers of severe Covid cases, the pandemic caused the year 2022 to start off on a bad note as well. Even if major openings are now imminent, the rapid spread of the Omicron variant continues to make restrictions necessary over significant parts of the first quarter that mainly affect contact-intensive service providers. High rates of worker absence are also likely to somewhat hamper growth from January to March, as roughly 1 % of the workforce is unavailable on average during the quarter as a result of reported infections alone. Overall, economic output can be expected to grow minimally at best in the first quarter, followed by vigorous catch-up growth in spring and summer. KfW Research expects GDP to grow by 3.2 % overall in 2022. Germany’s economic output is predicted to grow by 2.9 % in 2023. Russia’s attack on Ukraine as well as the further pandemic development in Europe and, particularly with a view to supply chains, China, along with the possible continuation of the excessively high rate of inflation are among the most immediate economic risks.

“Russia’s aggressions and the sanctions imposed in response hang over the further economic recovery of Germany and the euro area like a sword of Damocles”, said Dr Fritzi Köhler-Geib, Chief Economist of KfW. “More than anything, open warfare in Ukraine is having dramatic humanitarian and geopolitical consequences, besides further driving energy prices and inflation in the euro area. This will affect Germany in a particular way as it covers around 14 % of its final energy needs with Russian natural gas alone. Besides moderately affecting economic output through loss of purchasing power it will also disrupt energy-intensive production, especially if the need arises to ration energy supplies. At this stage, the impact on German and European economic output is almost impossible to predict. Now anything can happen – from another recession to around 3 % growth.”

Even so, the relaxation of the vast majority of pandemic restrictions planned in Germany for the end of March will likely provide a boost to pandemic-plagued services industries, where the catching-up potential is still high. Upside potential also exists in the manufacturing sector, where order volumes climbed to new record high levels every month last year as demand was high while production was hampered by material bottlenecks. On the assumption of diminishing pandemic-related limitations on global production and goods logistics, a shift from consumption back to services and the expansion investments already undertaken by producers of scarce inputs, material bottlenecks should improve to such an extent in the course of the year that manufacturing, too, will generate a noticeable growth surge. But this is based on the presumption that energy supply remains secure despite Russia’s attack on Ukraine. The ECB has estimated that rationing natural gas supplies by 10 % would reduce gross value added in Germany, which obtained around 58 % of natural gas supplies from Russia in 2020, by approx. 0.7 %.

All in all, KfW Research expects the German economy to grow by 3.2 % in 2022, which is a higher rate than in 2021 (+2.9 %). Growth in 2023 is likely to be high as well at 2.9 % (adjusted for calendar effects: 3.0 %) but with significantly flattening quarterly rates.

The euro area started the current year backed by noticeably higher growth at the end of 2021 with a statistical overhang twice that of Germany. The euro area can therefore be expected to grow at a higher rate overall this year as well. KfW Research expects GDP growth of 3.6 % for 2022, followed by 2.7 % in 2023.

The immediate risks to the German and euro area economies include the conflict with Russia, the threat of continuing inflation as well as the ongoing pandemic. “It is still possible that more virulent variants become dominant again or new severe waves of infection with the Delta variant emerge. Policymakers have the power to minimise the risk of high numbers of severe cases, overwhelmed intensive care units and renewed setbacks for many businesses by preparing the next booster campaigns and introducing general vaccine mandates in due time, at least for the elderly population,” said Köhler-Geib.

The current KfW Business Cycle Compass is available at:

www.kfw.de/konjunkturkompass