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Press Release from 2022-08-25 / Domestic Promotion, KfW Research

KfW Business Cycle Compass summer 2022: Between stagflation and recession

  • Economy began to slow from the middle of the year, impetus from recovery of services industry is waning
  • KfW Research expects German GDP to grow by 1.4% in 2022 and shrink by 0.3% in 2023
  • Inflation rate in Germany is forecast at 8.4% in 2022 and 5.1% in 2023 as pressure eases in the course of the year

The very strong need for catching up in the services industries, which had suffered under pandemic restrictions, generated strong growth in the first quarter and was still so strong in the second quarter that upward and downward forces for the German economy were roughly equal. But downward forces are likely to dominate from the middle of the year, mostly as a result of the consequences of Russia’s war of aggression against Ukraine and the energy crisis it created, but also the continuing disruptions to global supply chains, especially because of recurring strict lockdowns in China. After the catching-up movement in the services industries has now been practically completed, the enormous losses in purchasing power due to the sharply rising cost of living and adjustments to production in energy-intensive sectors are putting a dampener on economic activity.

KfW Research predicts slightly negative quarterly growth rates in Germany for the current third quarter and particularly for the winter half-year 2022/2023. A return to a moderate growth path is unlikely until the spring of 2023, when uncertainty over gas supplies decreases, energy-intensive industries have adapted their production and rising nominal wages combined with falling inflation rates slightly improve the trend in real incomes again. All in all, thanks to a successful start to the year the German economy is still set to grow by 1.4% in 2022 as a whole (previous forecast: +1.6%). The predicted contraction in economic output in the second half of 2022 and at the start of 2023 will mainly affect the growth forecast for the coming year for which KfW Research has downgraded its forecast to -0.3% (previous forecast: +1.2%).

“By definition, two consecutive negative quarters means we are in a technical recession”, said Dr Fritzi Köhler-Geib, Chief Economist of KfW. “In practical terms, however, our economic forecast means stagnation or – given the very high inflation we are seeing – stagflation in the coming year as opposed to a genuine recession. The moderate 0.3% contraction of GDP in our new forecast includes 0.2 percentage points which is attributable to a lower number of working days in 2023, meaning a negative calendar effect. As skills shortages remain high, we also expect relatively steady employment because in spite of the tense economic situation, businesses are thinking twice before dismissing any workers.”

The euro area is generally subject to the same economic forces as Germany. Nonetheless, many euro states, especially the large countries France, Italy and Spain, benefited to a particular degree from the strong recovery in the tourism sector in the past quarter. Also of advantage is that manufacturing plays a lesser role for their economy and is also slightly less dependent on international value chains and Russian natural gas supplies. Growth in the euro area therefore proved to be surprisingly strong in the first half of the year. It was 0.5% in the first quarter and even reached 0.7% in the second quarter. Euro area GDP already exceeds the pre-crisis level of GDP in the fourth quarter of 2019 by 1.5%. The impetus from the recovery of tourism will likely subside in the course of the current third quarter, however, before headwinds start to dominate in the autumn and the euro area also drifts into a technical recession. Because of the strong first half, KfW Research has lifted its forecast for euro area GDP in 2022 to 3.0% (previous forecast: +2.5%), but predicts a mere 0.5% growth for 2023 (previous forecast: +1.3%).

“Energy price inflation in Germany is likely to spike again in the autumn, driven by the recently adopted gas levy and regular gas and electricity retail price adjustments to reflect the massive increases in wholesale prices”, added Köhler-Geib. “Besides, disinflationary measures such as the 9-euro ticket and the fuel tax rebate are about to expire. This is further delaying the downward trend in the inflation rate. On average across the year 2022, inflation in Germany is predicted to be 8.4% as measured against the EU-wide comparable Harmonised Consumer Price Index (HCPI).” In addition to energy, food prices are adding to high inflation. However, the reported monthly total inflation rate is likely to drop in the course of 2023 as base effects from the previous year will reduce the contributions from energy and food price inflation. Increases in wages and prices of services from the end of 2022, however, will keep the pressure high on inflation without energy and food prices (core rate). In the second half of 2023 that rate will likely exceed the total inflation rate over several months. In the medium term, however, economic weakness and the ECB’s tighter monetary policy will dampen core inflation. For 2023 as a whole, KfW Research expects the inflation rate in Germany to remain a very high 5.1%, but mainly because rates will be high at the start of the year. Very similar inflation rates can be expected in the euro area both this year and next year (2022: +8.5%; 2023: +4.6%).

In view of the numerous uncertainties in connection with the war in Ukraine and its consequences, forecast uncertainty is currently exceptionally high. To address this uncertainty, KfW Research has also calculated an adverse scenario that is based on an imminent complete stop of Russian gas supplies. In that case, the German economy would perform much worse. First, even greater losses of purchasing power and decreases in consumption would have to be expected as a result of even higher expenditure on energy. Second, gas rationing would become more likely, mainly affecting large industrial enterprises. To calculate this scenario KfW Research assumed, among other things, a 10% to 20% rationing of gas consumption in particularly gas-intensive industrial sectors and significant second-round effects. Real growth of just under 1% could then be expected on average for the year 2022, while a contraction of around 2.5% would occur in 2023. Under such conditions, inflation would be even higher than in the base scenario, especially in 2023, but the inflation-reducing effect of recession could subsequently predominate.

The current KfW Business Cycle Compass is available (in German only) at:
www.kfw.de/konjunkturkompass