German economy has been stagnating for five years on balance

The German coalition government is called the Ampel-Koalition, after the colours of the SPD (red), FDP (yellow) and the Greens. In the meantime, the German economy has also become a kind of flashing light. In the fourth quarter of last year, GDP shrank by 0,2%.

As the first graph shows, growth and contraction have alternated for twelve quarters now. On balance, the German economy has been stagnating for five years. The election campaign was initially dominated by economic themes, but immigration has recently become the main topic of discussion. There is no doubt, however, that the new government will have to give priority to restoring economic progress.

Getting the German economy back on even a modest growth path will not be easy. Here is a list of challenges. The German economy relies heavily on the automotive industry. It is under pressure. That started back with 'dieselgate'. When new emissions standards had to be met, the German car manufacturers were not ready. When some recovery seemed to be on the way, the pandemic came and all kinds of supply problems arose that led to production problems, especially a shortage of chips played tricks on car manufacturers. Furthermore, they lagged (or are lagging?) far behind in the development of electric cars.

Another stronghold of the German economy is mechanical engineering. made in Germany-machines successfully found their way to China. In the meantime, the Chinese have learned a lot and can do it themselves at a fraction of the cost. In addition, Chinese economic growth is no longer self-evident and that puts a brake on German exports to that country.

De Energy transition that was implemented under Angela Merkel has led to much higher energy costs in Germany than in most other countries. That was already a problem before the war in Ukraine started. The end of Russian gas imports has pushed the increase in energy prices into overdrive. Because Germany has a relatively large amount of energy-intensive industry, the country has been hit harder by the high energy prices than other countries. We are also fortunate that in our country a number of players in the IT field have emerged from the Philips group (ASML, ASMI, BESI, NXP). For reasons that are not clear to me, that has not happened in Germany or has happened much less with, for example, Siemens, so that you can say that the industrial structure of Germany is not well prepared for the future.

Finally, the Merkel governments have always given high priority to keeping public finances balanced, even at the expense of infrastructure. This also applies to digital infrastructure. Anyone who has ever been to Germany knows that finding a stable internet connection is often a challenge.

Finally, the result, as mentioned, is that German GDP is currently no higher than it was in 2019, as the following figure shows.

Preliminary figures on economic growth in the fourth quarter were also disappointing in France and Italy. The French economy shrank by 0,1% quarter-on-quarter and the Italian economy stagnated. Spain shows a completely different picture. There, the economy grew above expectations: 0,8% quarter-on-quarter and 3,5% year-on-year. Real GDP of the eurozone as a whole stagnated, according to preliminary figures.

De economic sentiment index, the European Commission's broad monthly business barometer rose from 93,7 in December to 95,2 in January. That sounds encouraging, but the December figure was remarkably low. The index remains below its average since 1980.

Lagarde: I see, I see what you don't see
During her usual press conference after a policy meeting, ECB President Christine Lagarde said she expects the eurozone economy to pick up in the course of this year. As wage growth now exceeds inflation, purchasing power is improving. That is why the ECB expects private consumption to pick up. I have been expecting that for a while, but so far it has been disappointing.

Lagarde has further based her hopes on improving world trade and she believes that Europe will experience an export-led growth impulse as a result. I hope so too, of course. But given that the growth of the Chinese economy is under pressure and the new American president is threatening all kinds of import duties, I fear the worst.

If the consumer fails to show up and the expected growth in exports disappoints, where will the recovery of the European economy come from? This week, the ECB published the results of the so-called Bank Lending Survey. This is a survey among a large number of European banks that is held four times a year. The banks are asked about the development of their credit conditions, the demand for credit, etc. The results of the latest survey do not give much cause for optimism. On balance, banks tightened their conditions for lending to companies in the previous quarter. They say they see more risks while their willingness to take risks has actually decreased. You would not expect that in an improving economy. The credit conditions for credit to consumers were also tightened. Only with regard to residential mortgages did the credit conditions remain unchanged.

Banks have thus become less generous with loans to companies. The graph shows that the extent to which banks tightened their credit conditions in the last quarter of last year is not exceptional, so there is no immediate reason to panic. But this development is generally not a good omen for the economy. And given what I have discussed above, it is difficult to be optimistic about the economic development in the eurozone this year.

As expected, the ECB cut its official rates by 25 basis points this week, the fifth rate cut in this cycle and certainly not the last. Next Friday, the ECB will publish an analysis of the 'neutral level' of the interest rate. That is the rate that does not provide a boost or dampening effect on the economy. I expect the ECB to indicate a range that will not be too specific. That neutral rate will be around, but perhaps slightly above 2% for the deposit rate. With its interest rate policy, the ECB is certainly on its way to neutral. If I am right that Lagarde et al. are too optimistic about the economic outlook, then it is obvious to expect the ECB to cut rates further. I therefore think that we will fall below 2% later this year, compared to the current 2,75%.

Chinese entrepreneurs less positive
The purchasing managers' indices as published in China by the NBS fell in January. The subindex for industry fell from 50,1 in December to 49,1 in January. The index for the services sector fell from 52,2 to 50,2. The Chinese are now celebrating their New Year. That always leads to a lull in the flow of economic data, but these latest figures confirm the picture that the Chinese economy is struggling.

US: A bright spot
The Fed left its official rates unchanged as expected. That decision was unanimous. It is an understandable decision. The economy is doing very well, inflation is above target, the decline in inflation has stalled recently, and there is great uncertainty about the new administration's policies and their effects on the economy.

In previous press conferences, Fed Chairman Jay Powell has often appeared visibly uncomfortable when asked about his relationship with Trump. This time, there was no sign of negative body language, although Powell did not respond to such questions.

The US economy grew by 2,3% 'annualized' in the last quarter of last year compared to the third quarter. Expressed in European terms, the quarterly growth was 0,6%. The US quarterly growth was more than entirely driven by the consumer. Consumer spending increased by 4,2% annualized. Business investment had a negative impact. Investment in equipment in particular was weak: -7,8% quarter-on-quarter, annualized. Businesses also cut back heavily on inventories. That took 0,93% off GDP.

Although the growth figure was slightly lower than expected, it is still a good number. Corporate investment can be volatile, so I don't lose sleep over a quarterly decline. And the inventory cycle goes up and down. Sometimes companies eat into inventory, which limits GDP growth, and other times they build up inventory.

Regional business confidence indices released this week showed an improvement. The Dallas-Fed index rose to 3,4 in January from 14,1 in December. The Richmond-Fed index went from -10 to -4.

Closing
It is increasingly difficult to be optimistic about the German economy. In a few weeks there will be elections and hopefully the new government will succeed in implementing policies that will get the economy going. The challenges are very tough.

Watching the ECB press conference I wondered if they were talking about the same European economy as I see. I suspect that the ECB is still too optimistic and that it will eventually feel called upon to cut official rates even further.

The Chinese economy is still under pressure, and the threat of new US tariffs is not making things any better.

The US economy, on the other hand, is doing very well. The rather volatile style of the new president is adding to the uncertainties, but continued economic growth is in the offing.

Hans de Jong

Han de Jong is a former chief economist at ABN Amro and now a resident economist at BNR Nieuwsradio, among others. His comments can also be found on Crystalcleareconomics.nl

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