KfW Business Cycle Compass for spring: Recovery with one foot on the brake

• KfW Research expects German GDP to contract by -0.3% in 2023 and grow by 1.0% in 2024
• German inflation rate to hit 6.3% in 2023, 2.4% in 2024
• Ecological price tag: greenhouse gas emissions to exceed target trajectory by 5% in 2023 and 6% in 2024

The German economy is set to emerge from a technical recession in the winter half-year and return to a gradual growth path from the current second quarter 2023. Initially, the main drivers will be catch-up effects in industrial production and growth in business-related services, followed by a moderate recovery of household consumption, with positive effects on consumer-related services. For 2023 as a whole, KfW Research expects the growth rate of gross domestic product (GDP) to virtually stagnate compared with the previous year at -0.3%, since 0.2 percentage points of this decline is solely attributable to the lower number of working days compared with the previous year (calendar effect). The forecast for 2024 is for 1.0% growth. KfW Research thus reaffirms its previous forecast from February.

“Germany is experiencing an economic recovery with one foot on the brakes”, said Dr Fritzi Köhler-Geib, Chief Economist of KfW. “Waning supply shocks and increasing wages growth are bolstering the economy, while monetary policy continues to slow down activity in response to broad inflationary pressure. On balance, 2023 will likely see a virtual stagnation of economic output, but I expect around 1% growth for 2024. The downward revision today by Destatis to -0.3% from its rapid estimate at the start of the year of stagnation vis-à-vis the previous quarter is in line with the initial expectation we expressed in our February forecast. As the outlook and fundamental economic drivers have hardly changed since, the confirmation of our previous forecast is only logical.”

Over the past year, material and supply bottlenecks had already eased significantly all over the world and, with a slight delay, are becoming less and less of a constraint on production for businesses in Germany as well. Current wholesale energy prices are also bolstering the economy, especially for natural gas, the prices of which are now well below 2022 levels. As a consequence, production in sectors that were affected by material shortages, such as automotive engineering, has been expanding vigorously for some time now, and production in particularly energy-intensive areas such as basic chemicals has also been recovering since the start of the year. Another positive effect on economic output is coming from accelerating wages growth, which will stabilise household consumption in the course of the year. Monetary policy is having the opposite effect on the business cycle. Although the ECB will probably come to the end of its interest rate cycle this summer, the restrictive effect of the monetary tightening that began in 2022 is still intensifying. It was first felt in the significant decline in construction activity already last year. Alongside a massive drop in credit demand from households, banks are now also reporting much weaker demand for loans from businesses. The restrictive effect is likely to peak this year but should continue to be significant in 2024 as well.

The strongest dampening effect on prices from monetary tightening is not expected to occur until 2024 and 2025. However, the easing of supply bottlenecks is now filtering through to consumer price inflation as well, which fell from 11.6% last October to 7.6% in April, according to the Harmonised Index of Consumer Prices (HICP). The contribution of energy prices to inflation, in particular, has already fallen significantly in the past months and is expected to turn negative in the course of the year. Furthermore, steep drops in producer prices and sales price expectations are harbingers of falling inflation in the industrial goods components of the basket of goods in the near future. Wages, on the other hand, will likely become a more important driver of inflation but will probably be partly offset through declining profit margins. KfW Research therefore expects the downward trend in reported monthly inflation rates to continue. Total inflation in Germany is set to remain on a very high level of 6.3% this year, before dropping to 2.4% in 2024. Core inflation without energy and food is likely to remain slightly higher in 2024 than the overall rate.

KfW Research expects growth of 0.8% in the euro area for 2023, and although the outlook for the next quarters is similar to that of Germany, much of the higher growth is attributable to the greater momentum from the previous year (statistical overhang). In 2024 the euro area should experience growth of 1.1%, a similar momentum as Germany. The average annual inflation rate in the euro area will likely sit at 5.7% this year. Next year it should return to 2.2%, which is near the ECB’s inflation target.

Pressure to act on climate change remains high. According to the Ecological Price Tag for GDP, the new indicator for Germany which KfW Research introduced with its 2022 autumn forecast, our current economic forecast of -0.3% in 2023 and +1.0% in 2024 implies that greenhouse gas emissions will presumably be 5% higher this year and 6% higher next year than would correspond with the interpolated target trajectory of a 65% reduction by 2030 against the 1990 baseline.

The current KfW Business Cycle Compass is available at:

www.kfw.de/konjunkturkompass