Germany Is Finally Coming To The Eurozone’s Rescue

We believe that Germany’s weak Q1 2013 GDP reading – minus 1.4% y-o-y in non-seasonally adjusted terms – masks an important shift in the shape of growth, which we expect to be characterised by higher levels of consumption and weaker exports over the next few years.

Given that exports comprise over 50% of Germany’s GDP, a proportion that is only slightly below private consumption, this shift is not necessarily supportive of stronger growth, and we may well revise down our 2013 real GDP growth forecast of 0.8%, once we get the second estimate of Q1 GDP (due for release on June 5).

Nevertheless, we have long argued that for the eurozone to emerge from economic stagnation, Germany would need to ‘pay’, either through investment into periphery states or higher domestic consumption. Leading indicators, combined with the recent change in rhetoric from Chancellor Angela Merkel’s centre-right government, imply that both are now occurring.

Don’t Be Fooled By Weak GDP

Low headline German growth is not necessarily bad for the eurozone, given that it is a lack of German domestic demand (rather than simply lack of GDP growth) which is holding back the region’s economic recovery. Indeed, while the German economy managed to continue expanding last year, this offered little support to periphery states, as German growth was driven almost entirely by exports. However, with German export growth waning in line with slumping Asian (primarily Chinese) demand and massive euro appreciation against the Japanese yen, which is hurting German exporters in key markets, there is now a need for Germany to boost domestic demand, if it wants to keep its own GDP growth in positive territory.

Flash estimates of Germany’s Q1 2013 GDP suggest that it was private consumption which compensated for weaker export growth, helping the economy expand by 0.1% in seasonally-adjusted terms from the previous quarter (thereby ensuring Germany escaped a technical recession). With exports set to remain weak and with limited sign of a recovery in domestic investment, consumption will have to continue taking up the slack, and on this front we believe the outlook is relatively rosy. For instance, not only are union negotiations delivering higher wage increases, but the GfK Consumer Climate study showed that German consumers have become much more positive in recent months, particularly in terms of their ‘willingness to buy’.

‘Not Just The World’s Best Savers’

We do not expect German consumption alone to be strong enough to drive the recovery process in the eurozone periphery, particularly given that Germans import most of their consumer goods from elsewhere (mainly Central Europe and Asia). However, combined with the government’s recent announcement of bilateral investment programmes in periphery states, it now appears that there is an increasing German political will to save the eurozone. Perhaps more importantly, as this announcement comes just four months ahead of the September 2013 federal election, it implies that Chancellor Merkel’s administration believes the German electorate wants to see the country reassert its leading role within the single currency union.

This position is reinforced by Finance Minister Wolfgang Schaeuble’s statement that the government now wants to show that Germans are ‘not just the world’s best savers’, implying it is now willing to relinquish its obsessive focus on fiscal austerity. There are, of course, other potential explanations for this change of tone, which could be viewed as a ploy to boost demand for the country’s capital-intensive exports. Nevertheless, whatever the motivation, we believe the signal alone is strong enough to be supportive of investor sentiment towards the periphery.

Financial Market Implications

If we are right about the changing shape of growth and investor sentiment towards the eurozone as a whole, there are signification implications for assets. To some extent, we believe this is already reflected in German equities, with the DAX having smashed through to record highs in May. However, we do see more potential in Central European equity markets, which have significantly underperformed both developed and other emerging market stocks over the past few quarters.

We also believe that the impact of stronger wage growth would be higher inflation (both consumer and asset prices) in Germany, which, combined with a more positive outlook towards the eurozone as a whole, would be negative for fixed income. If 10-year bund yields break through key technical support at 1.52%, it would support our long-held view that ultimately Germany is on the hook for the survival of the single currency union, and at some point this is likely to be reflected in higher sovereign borrowing costs.


In yesterday’s blog post, we stated that Costa Rica is a member of the Pacific Alliance. In fact, Costa Rica is not yet a full member.