By Eiko Sievert and Julian Zimmermann, Sovereign and Public Sector Ratings

We have further revised down our forecast for economic growth in Germany (AAA/Stable) to between 2% and 2.5% this year and 3% in 2023 (see Table 1), having expected growth this year of 4.4% before Russia’s full-scale invasion of Ukraine at the end of February. This will continue to put a strain on businesses and hamper Germany’s recovery from the pandemic crisis with economic output now expected to return to pre-pandemic levels in the second half of this year.

We see further downside economic risk, in particular in the case of an EU embargo on gas and oil imports from Russia and a drawn-out war in Ukraine without any resolution this year. Leading economic research institutes estimate that an immediate embargo of Russian oil and gas would significantly slow growth in 2022 and cause a deep recession in 2023 with the economy contracting at least 2%.

To underline the uncertainty affecting the outlook for Europe’s biggest economy, we have summarised latest baseline growth projections for Germany, covering various scenarios regarding the progression of the war in Ukraine (CCC/Under review for a developing outcome) and future sanctions, energy embargoes and commodity prices.

Table 1: Real GDP growth forecasts for Germany

Russia’s invasion of Ukraine has increased already strong inflationary pressure, driven by a sharp surge in energy prices. These price rises have increasingly fed through to broader inflation for other goods and services in Germany, see Chart 1.

Chart 1. German consumer price index and oil price

Note: The shaded area represents forecast values from the German Council of Economic Experts. Source: Macrobond, German Council of Economic Experts, Scope Ratings.

The responsiveness of the German consumer price index to energy prices has also been higher than in previous periods. This reflects a development acknowledged by the Bank for International Settlements, in which inflationary pressures affecting one sector are increasingly having spillover effects on other sectors, notably in Germany’s export-driven economy with its exposure to long and complex international supply chains.

Rapidly rising inflation exerts pressure on real incomes and household spending. To some extent, increased household savings during the pandemic and full order books will help cushion this impact. However, high frequency indicators on household consumption, such as the GfK’s consumer sentiment index, are already pointing towards a significant contraction of household spending in Germany in response to higher prices.

In 2022, private consumption will be one of the major channels driving lower growth in Germany alongside any continued supply chain disruptions affecting industry. Still, any adverse effect of higher commodity prices on private consumption will be partially cushioned by the German federal government’s plans for EUR 30-35bn (about 1% of GDP) in spending to alleviate cost-of-living pressures. As Germany shifts away from its black zero fiscal policy, the full set of measures will appear in the next budget revision due 27 April.

To assess the effects of higher energy prices on real consumer spending, we use the differential between overall output inflation and private consumption inflation (GDP deflator – private consumption deflator). This indicator aims to capture the squeeze on real disposable income of households triggered by increases in prices in consumption outpacing those for overall national output. Higher energy prices also lead to price hikes of other final goods due to higher intermediate goods prices. As Germany imports essentially all its oil and gas, any increases in the price of energy imports lead to a deterioration of the country’s terms of trade (i.e. prices of exports relative to prices of imports) and therefore its wealth and output. The economy thus does not benefit from higher fossil fuel prices, as rents for these are exported abroad.

Over the past decade, the differential was positive in almost every quarter since 2012, with price increases of private consumption averaging 1.3%, 0.3pps lower than an average 1.6% for overall GDP deflator inflation. As global oil prices retreated and a low-inflation regime took hold, households in Germany enjoyed positive contributions to their real disposable income. The negative differential in 2022 of an average 1.3% reflects the significant pressure on private consumption this year (see Chart 2).

Chart 2. Deflators of GDP and private consumption in Germany
%-change, YoY

Note: * The differential is calculated as the GDP deflator %-change YoY minus the private consumption deflator %-change YoY. The shaded area shows forecast values from the German Council of Economic Experts. Source: Macrobond, German Council of Economic Experts, Scope Ratings.