KfW Research: KfW Business Cycle Compass August - Despite headwinds, consumption-driven recovery possible from autumn on

• KfW Research expects German GDP to contract by -0.4 % in 2023 and grow by 0.8 % in 2024
• German inflation to hit 6.3 % in 2023, 2.5 % in 2024
• Ecological price tag: Greenhouse gas emissions to exceed reduction target by 5 % in 2023 and nearly 6 % in 2024

Following a mild GDP contraction in the first half of the year, business sentiment deteriorated in Germany in the summer. However, KfW Research expects a cyclical turnaround from the coming quarters that will be driven primarily by a revival of household consumption. On balance, we expect gross domestic product to roughly stagnate in the course of 2023. Owing to the contraction at the end of the previous year (statistical underhang) and the fact that the year 2023 has around two fewer working days than 2022 (calendar effect), annual price-adjusted gross domestic product should be 0.4 % below that of the previous year (previous forecast: -0.3 %). On the assumption that quarterly growth will then accelerate moderately from the middle of next year, we forecast real growth of 0.8 % for 2024 (previous forecast: +1.0 %).

“There is a chance of a consumption-driven economic recovery from autumn of this year – if with strong headwinds”

, said Dr Fritzi Köhler-Geib, Chief Economist of KfW.

“Leading indicators for the current quarter are disappointing, but the continuing high stock of orders reported by businesses should sufficiently stabilise production so that stagnation is more likely than a clear contraction. Towards the end of the year, significant wage increases along with easing inflationary pressure should then drive economic growth.”

Economic conditions in Germany have hardly changed this summer. Besides the dissolution of the material shortages that were so omnipresent in manufacturing and construction last year, the steep downward trend in import prices for fossil fuels are also positively impacting on the business cycle. As a consequence, producer prices are falling, and consumer price inflation is decreasing as well. In combination with accelerated wage growth, this suggests that household purchasing power will increase and the growth in consumption rekindled in the past quarter will continue.

On the other hand, monetary policy will continue to dampen economic activity. To be sure, the ECB has probably reached or almost reached the peak of the interest rate cycle, but interest rate reductions are unlikely to begin until sometime in the course of 2024. Inflation in Germany is set to remain on a very high 6.3 % in 2023 (HICP) before dropping to a mere 2.5 % in 2024. Average annual inflation rates in the euro area are likely to sit at 5.5 % in 2023 and 2.3 % in 2024.

Monetary tightening continues to put the brakes on construction investment, particularly in dwellings. The high interest rate level is also dampening demand for business loans. But given the urgent need for investment particularly in the energy transition, climate neutrality and digitalisation projects, and the pent-up demand for capital goods, where supply problems previously paralysed manufacturers, business investment is nevertheless likely to grow moderately in the second half of 2023 and in 2023 as a whole. In the coming year, investment activity is then likely to accelerate slightly on the back of a consumption-driven economic recovery in Germany and many of its trading partners.

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

KfW Research expects a significantly higher GDP growth rate of 0.7 % for the euro area than for Germany, especially as a result of the better first half of the year and the statistical overhang from the previous year. The euro area is likely to grow by a rate of 1.0 % in 2024.

The current KfW Business Cycle Compass is available at:

www.kfw.de/konjunkturkompass