German Q4 GDP details reveal surprisingly robust investment alongside significant drag from negative net exports

Component data now released for the fourth quarter of 2015 confirm – as already shown by "flash" data released by the Federal Statistics Office (FSO) on 12 February – that German real GDP increased 0.3% quarter-on-quarter (q/q), which matches the pace observed in the third quarter and is slightly weaker than the 0.4% average during the first half of 2015. The fourth-quarter expenditure breakdown reveals that fixed investment was surprisingly firm while net exports weighed on GDP growth even more than in the preceding quarter. As indicated on 12 February, private consumption growth slowed considerably whereas the increase in public consumption, fuelled not least by refugee-related expenditure, had twice the momentum of the third quarter. Overall domestic demand growth strengthened from 0.6% q/q in the third quarter to 0.8% q/q in the fourth. As inventories added 0.1 percentage point to quarterly GDP growth (same as in the third quarter), final domestic demand has picked up from 0.5% to 0.7% q/q. This is more than twice the long-run average and stronger even than during the past two-and-a-half years, in which domestic demand has already been relatively robust. Nevertheless, this has not resulted in any acceleration of overall GDP growth in the fourth quarter because net exports had a larger negative impact than in the third quarter. Exports per se have declined versus the previous quarter for the first time in three years and imports have increased modestly, despite initial indications from the FSO suggesting a (smaller) decline. Unadjusted for calendar factors, the year-on-year (y/y) rate of overall GDP growth has increased from 1.7% to 2.1%, but this owes to a large calendar effect. The seasonally and calendar-adjusted series actually softened from 1.7% to 1.3%. Nevertheless, counter to common perceptions, underlying annualised GDP growth momentum in the German economy is poised to accelerate from close to 1.5% in late 2015 to the 2% area in early 2016.

Looking at developments of the individual components in the fourth quarter, the breakdown reveals the following about GDP growth contributions: Net exports subtracted 0.5 percentage points from quarterly GDP growth, having already subtracted 0.3 points in the third quarter. At the same time, domestic demand net of inventories added 0.7 points, up from 0.5 points in the third quarter. A light increase in the stock of inventories boosted GDP growth by 0.1 percentage point, as in the third quarter. This contrasts with a deduction from GDP growth to the tune of 0.3 points in the second quarter 2015 and reinforces the impression that firms no longer strive to cut down on stocks due to concerns about future demand. Among the components of final domestic demand, private and public consumption contributed 0.1 and 0.2 percentage points, respectively, to quarterly GDP growth in the fourth quarter. Fixed investment added 0.3 points, the breakdown showing that investment in equipment contributed 0.1 points and construction investment 0.2 points (best performance since the weather-related boost by 0.4 points in the first quarter 2014).

Net exports burdened GDP growth to greater extent than before as exports declined in Q4

The negative growth contribution of -0.5% from external demand was the result of declining exports of goods and services (-0.6% q/q) being accompanied by still increasing imports at 0.5% q/q, although the latter also slowed down from 1.1% in the third quarter. Net exports thus weighed on GDP to an even larger extent than in the third quarter (then -0.3%), contrasting with a positive contribution of 0.6% of net exports during the second quarter. Imports have now outperformed exports in growth terms during four of the past five quarters. During those five quarters, exports only grew at 0.9% on average whereas imports increased 1.3% q/q. German exports had held up quite well until the third quarter 2015 in view of a background of escalating geopolitical crises (Ukraine, Iraq/Syria) and worsening problems in several key emerging markets, but they have suffered a setback now. Belatedly, this is also reflected by the export orders component of Germany's PMI survey, which had reached a 22-month high in December but has shown a sizeable downward correction to only just above the neutral level of 50 during January/February. This can partly be explained by the upward correction of the euro since the start of 2016. Imports have increasingly reflected the acceleration in domestic demand that has developed since mid-2014, but they are also being restrained by the loss of export momentum as this reduces the export industry's demand for intermediate goods imported from abroad.

Final domestic demand has strengthened in underlying terms lately

Private consumption at 0.3% q/q was relatively weak, the growth pace falling to about half of that observed during the five preceding quarters. In view of the persisting, extremely supportive domestic environment for consumer spending, including healthy labour market and wage developments alongside softening oil and food prices that have boosted purchasing power, this is likely to prove an aberration to the downside that should be recouped in early 2016. Indeed, the ECB's policy of quantitative easing since March 2015 seems likely to be expanded once more shortly, which will keep interest rates near record lows and thus provide an ongoing disincentive to save.

Government consumption growth accelerated from 0.5% q/q (revised down from 1.3%) to 1.0% q/q. In addition to the loosening of German fiscal policy since the grand coalition government came to power in late 2013, the expanding inflow of migrants since mid-2015 is playing an increasing role as the state cares for their subsistence needs. The latter is facilitated by strong public finances – at 0.6% of GDP, Germany enjoyed the largest budget surplus since the year 2000 (then 0.9%, owing to the special factor of a sale of UMTS frequency licences for mobile phone networks). By spending part of this surplus in 2015 and other parts in 2016 and 2017, Germany is providing fiscal stimuli now – and should continue to do so as the migrant influx will not stop anytime soon. As tax revenues remain on a solid expansion path, the public sector can most likely still prevent slippage into deficit during 2016–17.

Meanwhile, fixed investment increased 1.5% q/q, returning to the pace of the first quarter of 2015. However, much of the latter had been due to an increase in construction linked to unusually mild winter weather, whereas the latest rise in fixed investment reflects more underlying strengthening. The temporary reduction of political uncertainty following the resolution (for some time at least) of the Greek debt crisis during the third quarter may have helped. The split between the two major components of fixed investment shows that equipment investment accelerated from 0.2% q/q (revised up from -0.8% originally) to 1.0% q/q. Construction investment – which constitutes about 50% of overall fixed investment versus just 32% for investment in equipment – even swung from -0.2% q/q in the third quarter to 2.2% q/q in the fourth. Leading indicator evidence from the construction sub-index of the Ifo business climate survey had already signaled such a rebound in recent months. Indeed, this Ifo survey component reflected a further increase in activity in January/February, although expectations concurrently worsened in this sector. Separately, note that gross overall investment, i.e. including also inventories, has accelerated from 0.5% q/q to 2.4% q/q.

Outlook and implications

The latest indications gleaned from key leading indicators have mostly been negative. Thus purchasing manager (PMI) data for the manufacturing sector and the indices of the Ifo business climate and ZEW surveys have all deteriorated anew since either December or January. However, the preceding upswing during 2015 (except for the ZEW survey) has not been fully reflected in the GDP data yet, and the German service sector remains very robust in any case due to the boost to consumer purchasing power provided by ongoing healthy employment growth and sharply lower oil prices. In addition, both monetary policy (the ECB is likely to expand quantitative easing in March) and fiscal policy (expenditures on refugees and infrastructure will rise, financed by the existing budget surplus) are supportive for economic growth. Finally, residential construction will enjoys an ongoing upward trend due to extremely favourable financing conditions and a lot of structural demand, not least also due to the large number of immigrants that have to be housed in some way or another. On balance, these factors should offset the dampening influence on GDP growth stemming from weaker emerging market demand.

Overall, IHS Global Insight has projected in its February forecast round that calendar-adjusted year-average German GDP growth, following 1.6% in 2014 and 1.4% in 2015, will accelerate modestly to 1.9% in 2016. Unadjusted for calendar factors (as used for official government forecasts), growth acceleration will be even more modest from 1.7% in 2015 to 2.0% in 2016. Although downside risks have clearly become more visible in recent days, it nonetheless needs to be remembered that the export-dependent manufacturing sector, which is the main focus of attention of the key leading indicators, only represents about a quarter of the German economy. Those sectors with the highest growth momentum at present, namely services, construction, and government consumption, are grossly underrepresented in those leading indicators. As such, the underlying pace of economic growth is easily underestimated now. Furthermore, the unexpected momentum of investment growth in the final quarter of 2015 (both equipment and construction) should also temper concerns about near-term demand prospects. Quarterly GDP growth should thus be around 0.5% q/q during the coming quarters, implying an annual growth pace near 2%.