KfW Business Cycle Compass: Strong recovery after April low, but headwinds are building

• KfW Research expects Germany’s economic output to drop by 6% in 2020, forecasts 5% growth in 2021
• Euro area economy set to plunge by an even sharper -8% in 2020, catch-up growth of 6% expected for 2021
• Second coronavirus wave is main risk

The coronavirus pandemic has led to an economic slump of unprecedented scale in Germany and the euro area. The April low was followed by a swift catch-up movement, but its initially fast pace is already set to slow considerably. After the relatively mechanical recovery enabled by the relaxation of many containment measures, the remaining gap to pre-crisis levels of economic activity is becoming increasingly difficult to close. KfW Research stands by its forecast that Germany’s gross domestic product will contract by around 6% in 2020, before growing again by 5% in the coming year. The pre-crisis level will probably be achieved again by the end of 2021. Gross domestic product in the euro area is set to shrink by approx. 8% overall this year. Catch-up growth of around 6% can be expected for 2021.

In Germany, the export-oriented manufacturing sector in particular is expected to face increasing headwinds from the demand side. Uncertainty remains extremely high amid rapidly rising global coronavirus infection rates. In addition, crisis-induced higher debt levels are putting the brakes on businesses’ domestic and international capital expenditure activities. Moreover, unemployment in Europe will likely continue to grow for the time being, and this is set to have second-round effects on consumption and, in particular, on the sale of durable goods such as automobiles. And with case numbers increasing again in Germany as well, certain service areas such as the hospitality and event sector can be expected to face a tightening of existing restrictions rather than a relaxation.

“I expect catch-up growth in Germany and Europe to continue only at a very slow pace in the autumn and winter quarter”, said Dr Fritzi Köhler-Geib, Chief Economist of KfW. “But as the development of vaccines is progressing quickly, it is realistic to assume that wealthy economies such as the euro states can begin mass immunisations from spring 2021. An effective coronavirus vaccine would be a game changer. That would enable further containment measures to be lifted and boost confidence. We will then be able to return to pre-crisis GDP levels by the end of 2021. Overall, the coronavirus crisis will probably lead to a loss of around EUR 340 billion in economic output compared with potential growth in 2020 and 2021.”

A pronounced second wave of infections in Germany and in Europe, however, continues to be a significant downward risk for the economic recovery. Starting from a low level, many European countries as well as Germany have reported rising daily new infections again since mid-July. KfW Research expects a base scenario in which the rise in new infections can be stopped with more effective tracing of infection chains and economically relatively innocuous measures such as stricter mask-wearing requirements, restrictions on private gatherings and more consistent enforcement of distancing rules already in place.

The current KfW Business Cycle Compass is available at www.kfw.de/konjunkturkompass.