Domestic Growth Drivers To Improve

BMI View: German domestic demand will recover from a poor Q413 in early 2014, despite weaker external demand from emerging markets. We maintain our above-consensus real GDP growth forecast of 1.9% for this year, but expect growth to slow to a tepid 1.5% by 2015.

After a soft patch in Q413, which saw German real GDP growth modestly undershoot our full-year estimate - at 0.4% compared to our 0.5% estimate - economic activity looks to be on a stronger footing in early 2014. The manufacturing sector is once again the catalyst, with the Markit/BME manufacturing purchasing managers' index (PMI) reading hitting a three-year high of 56.5 in January. However, while the survey suggests that the pickup is mainly thanks to external (particularly US and Asian) demand, a stronger outlook for manufacturing bodes well for both consumption and fixed investment in 2014, with the sector still employing around 18% of the workforce (one of the highest ratios out of all developed economies).

This supports our view that GDP growth will continue to be driven mainly by domestic demand rather than net exports. Indeed, while we were slightly too optimistic on growth for 2013, our expectation of a shift in the shape of growth ( see 'Households To Become Principal Growth Driver', April 5, 2013) is playing out, with the Federal Statistics Office reporting that net exports contributed negatively to the headline growth rate for the first time since 2009.

Positive Signals For Domestic Demand
Germany - Industrial Production (SA) % chg y-o-y and Markit / BME Manufacturing PMI

BMI View: German domestic demand will recover from a poor Q413 in early 2014, despite weaker external demand from emerging markets. We maintain our above-consensus real GDP growth forecast of 1.9% for this year, but expect growth to slow to a tepid 1.5% by 2015.

After a soft patch in Q413, which saw German real GDP growth modestly undershoot our full-year estimate - at 0.4% compared to our 0.5% estimate - economic activity looks to be on a stronger footing in early 2014. The manufacturing sector is once again the catalyst, with the Markit/BME manufacturing purchasing managers' index (PMI) reading hitting a three-year high of 56.5 in January. However, while the survey suggests that the pickup is mainly thanks to external (particularly US and Asian) demand, a stronger outlook for manufacturing bodes well for both consumption and fixed investment in 2014, with the sector still employing around 18% of the workforce (one of the highest ratios out of all developed economies).

Positive Signals For Domestic Demand
Germany - Industrial Production (SA) % chg y-o-y and Markit / BME Manufacturing PMI

This supports our view that GDP growth will continue to be driven mainly by domestic demand rather than net exports. Indeed, while we were slightly too optimistic on growth for 2013, our expectation of a shift in the shape of growth ( see 'Households To Become Principal Growth Driver', April 5, 2013) is playing out, with the Federal Statistics Office reporting that net exports contributed negatively to the headline growth rate for the first time since 2009.

Nevertheless, this does not mean that Germany is immune from a drop in external demand, as we expect buoyant consumer and business confidence readings to suffer over the next few months from deteriorating sentiment towards emerging market growth. Weakening Asian (particularly Chinese) demand is perhaps the biggest threat to German exporters, given the increased role this region has played in corporate expansion plans over the past few years, and this in turn could act to dampen domestic confidence before the recovery really gains traction.

Asia Has Become Much More Important
Germany - Exports To Region, % Total Exports

Our core scenario is that strengthening domestic demand will prove resilient enough to overcome weaker EM growth, hence our decision to remain slightly above-consensus on German GDP growth in 2014 - at 1.9% compared to Bloomberg consensus estimates of 1.7%. While we expect this trend to continue beyond 2014, with exports still comprising over 50% of GDP, stronger domestic demand alone does not point to a particularly rosy medium-term growth outlook, hence our forecast for a more modest 1.5% average annual rate of expansion over the next five years.

GDP By Expenditure Breakdown

Private Consumption: We lack the full-year GDP by expenditure breakdown to confirm the strength of private consumption for 2013, but based on the first three quarters it was clearly one of the main contributors to headline growth. That said, delayed hiring by firms despite still strong external demand meant that wage growth tapered off in the latter stages of the year, which weighed on the pace of consumption growth.

This now looks to be changing, with the January Markit/BME report showing backlogs of work rising for the fourth straight month, and at the fastest rate in almost three years. This implies a tightening labour market, which bodes well for both job creation and real wage growth in early 2014, especially given the absence of significant supply-side inflationary pressures. Government policy should also prove supportive of stronger household expenditure, with flagship policies of the new coalition government including more generous pension provisions and the introduction of a national minimum wage.

In Need Of Immigrants
Germany - Population By Age, 000 (2012e*)

Another positive for private consumption growth are recent immigration trends, with net migration up 13% y-o-y in H113 according to recently-released data from Destasis. While we expected a steady influx of migrant labour to mitigate the impact of a top-heavy demographic profile on the size of Germany's workforce, we had not expected the number of arrivals from periphery eurozone economies to be quite so rapid. This has prompted us to revise up our population forecasts, and reinforces our expectations for private consumption to contribute a healthy 1.4 and 0.9 percentage points (pp) to real GDP growth this year and next.

Government Consumption: Despite the above-mentioned pledges of more generous pension packages and a national minimum wage, the government's steadfast commitment to reducing the public sector debt burden towards 60% of GDP (as per Maastricht criteria) implies fiscal expenditure growth will be tied to revenue performance. Better growth prospects for this year and next suggest the government consumption contribution to GDP will be positive, but only around the 0.1-0.2pp range, according to our forecasts.

Gross Fixed Capital Formation: Rising capacity utilisation and order backlog levels imply private-sector fixed investment is poised for a decent recovery in early 2014. This is a strong positive for headline growth, since collapsing gross fixed capital formation (GFCF) growth was the main factor behind Germany's poor economic performance over the past two years.

Confidence Crucial
Germany - Ifo Business Climate Survey and GFCF (RHS)

As outlined above, confidence may take a hit from weaker EM demand, which could see some companies shelve expansion plans despite the current supply shortage. Nevertheless, even in such a scenario our Infrastructure team is optimistic that a healthy projects pipeline, with a large number of projects moving into the construction phase in 2013, bodes well for GFCF growth in 2014. We project GFCF to contribute 0.3pp to growth this year, before cooling to 0.1pp in 2014.

Net Exports: Slower wage growth in H213 led to an improvement in productivity levels in terms of both output per man-hour and wage cost per product unit, according to recent data compiled by the Bundesbank. Although we expect a slight reversal in this trend due to labour market tightness in 2014, it still bodes well for Germany's share of global trade, reflected in export data which shows the ability of German exporters to shift supply to those markets where demand is strongest.

However, we do believe German export growth will feel the impact from a slowdown in EM, particularly Asian demand, driven in large part by China's painful economic rebalancing process. At the same time, stronger domestic demand will see imports increase and/or exports fall (as more domestic production is consumed at home), implying another year of negative contribution from net exports.

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Related sectors of this article: Economy, Economic Activity, Fiscal Policy
Geography: Germany, Germany
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