Detailed German Q2 GDP Data Reveal Strong, Broad-Based Upswing

According to detailed second-quarter data from the Federal Statistics Office (FSO) adjusted for seasonal and calendar factors, German real GDP not only increased at its fastest quarterly pace since reunification in 1990, by 2.2% quarter-on-quarter (q/q), but it was driven by all of the major demand components. This confirms the preliminary number released on 13 August. Furthermore, GDP levels for the entire period since the beginning of the global economic crisis, i.e. since the fourth quarter of 2008, have been revised upwards, most strongly so for the first quarter of 2010 (from growth of 0.2% to 0.5% q/q). This means that much more (almost 60%) of the sharpest economic contraction in post-war history (7.1% during the second quarter of 2008 to the first quarter of 2009) had been recouped by mid-2010 than previously expected. Year-on-year (y/y) growth, again calendar adjusted, has been improving since the trough in the first quarter of 2009 (when GDP fell 6.6% y/y), rising from 2.0% in the first quarter of 2010 to 3.7% in the second. A moderately positive working-day effect even results in an improvement in the annual growth rate in unadjusted terms from 2.1% to 4.1%.

Net Exports Boost Q2 GDP As Exports Regain Upper Hand

The breakdown by individual expenditure component shows that net exports added 0.8 percentage point to quarterly GDP growth in the second quarter, having deducted 1.1 percentage points in the first quarter but added an even larger 1.9 percentage points in the fourth quarter of 2009. Exports increased 8.2% q/q, the fastest pace of growth since the boom in the third quarter of 1990 when East Germany received the Deutschmark a few months before reunification. Imports also grew strongly by 7.0% q/q, which was also the highest figure for 20 years. Unlike in the first quarter, imports were not so much driven by a replenishment of inventories but rather by the need to have inputs to hand for increased current production. Many of Germany's exporting firms rely on inputs produced abroad, which helps to explain why the current export recovery is being accompanied by such a strong rebound in imports. Exports will additionally continue to benefit in the coming months from the marked depreciation of the euro observed during 2010 so far. That said, the decline in the purchasing managers' index (PMI) sub-index for export orders seen during May-August signals that export growth momentum will wane overall in the months ahead. This is not yet visible in the VDMA data stemming from Germany's internationally competitive but also cyclically exposed key plant and machinery sector. Record y/y rates exceeding 60% in May/June also reflect the depth of the downturn a year earlier, meaning that such annual rates will fall sharply in late 2010 and during 2011. This lag also mirrors the fact that the product mix with its many investment goods implies relatively long lead times for technical reasons. Meanwhile, import strength is indicative of improving domestic demand with regard to both investment in equipment and private consumption, the latter benefiting increasingly from falling unemployment.

Final Domestic Demand Components All Show Solid Increases

Domestic demand components all strengthened during the second quarter, with one-off factors such as the unwinding after a particularly severe winter and the withdrawn car scrappage subsidy providing additional impetus. The rebuilding of inventories hardly played a role, boosting quarterly GDP growth by a mere 0.1 percentage point. Companies apparently tried to add to their stocks in reaction to strongly increasing demand but only just managed to keep up with the latter in terms of their production. This contrasts with the contribution of 1.0 percentage point in the first quarter. Although the inventory data as usual have to be treated with caution—this is a volatile category largely based on estimates and is also used as a residual—it can be said that the risk of any upcoming backlash due to overextended inventory accumulation is small. Demand has increased quickly enough to prevent any build-up of potentially unneeded stocks. Overall domestic demand boosted quarterly GDP growth by 1.4 percentage points, domestic demand minus inventories by 1.3%, its best performance since late 2006 (when there was a boom ahead of a value-added tax rise). Among the latter, construction investment added 0.5 percentage point, investment in equipment 0.3 percentage point, private consumption 0.3 percentage point, and public consumption 0.1 percentage point.

Looking at individual components more closely, private consumption increased 0.6% q/q, its first positive growth in a year. During the three preceding quarters, the expiry of the car scrappage subsidy in early September 2009 had represented a significant burden, producing an unwinding effect after unexpectedly firm data during the first half of 2009, at the height of the recession. The shift from falling inflation in 2008–09 to a partial rebound since late 2009 has also contributed to this pattern via its impact on consumer purchasing power.

Government consumption increased 0.4% q/q, having shot higher by 2.0% q/q during the first quarter. This will probably not decline during the next two quarters, but a weakening is foreseeable for 2011 when fiscal consolidation is tackled in earnest.

Fixed investment growth accelerated markedly from 1.2% in the first quarter to 4.7% q/q in the second, which mainly reflects the weather-related rebound in construction investment (from -0.7% to 5.2%), whereas the revised data now show steady growth of 4.4% q/q for equipment investment in both the first and second quarters. Given that demand and also capacity utilisation levels have been continuing to rebound in recent months, and given that leading indicators such as the Ifo expectations index and purchasing managers' index (PMI) remained at high levels until at least July, investment can be expected to post solid further growth during the remainder of 2010. This is true despite the persistent uncertainty stemming from financial sector problems.

Outlook and Implications

Overall, the historically high levels of leading indicators until at least July suggest that the current economic recovery is so well underpinned that even the current slowdown in global growth will not derail the German upswing altogether. This is not so much a consequence of the weaker euro, which does have a supportive effect by enabling gains in German market share, but more importantly reflects growing domestic demand momentum within Germany itself. Consumer spending is being fuelled by an increasingly bright labour market outlook, this in turn being not just a cyclical phenomenon but also a structural one: demographics are tending to reduce labour supply, which will give employees greater bargaining power in upcoming wage rounds. Furthermore, the equipment investment cycle is only now starting to gain momentum and construction is still being supported by infrastructure projects coming on stream as a consequence of economic stimulus packages launched in 2009.

Nevertheless, the extreme growth pace of the second quarter cannot be repeated during the second half of 2010, with q/q growth close to 0.5% being the most likely outcome. This also follows from the likelihood that import growth will exceed export growth in the third quarter and perhaps also the fourth, related to the pull exerted by strengthening domestic demand. As a result, the net export contribution could well turn negative again. Furthermore, the risks from abroad—be they in the form of weaker U.S. and/or Chinese growth or renewed disruptions due to the Eurozone debt crisis—lean to the negative side.

Notwithstanding entinancial sector problems and the need to unwind fiscal stimulus programmes worldwide in 2011, IHS Global Insight has now lifted its prediction for German GDP growth in 2010 from 2.0% to 3.2% in its August detailed forecast round, followed by growth of 2.0% in 2011. The latter will mirror the slowdown in the pace of growth that we anticipate in the coming months. Alongside much weaker growth developments in most of the remainder of the Eurozone, this leads us to continue to expect the European Central Bank to keep monetary policy soft well into 2011. This will keep interest rates at levels that are too low for German economic conditions for quite some time yet, supporting German domestic demand—the opposite of the situation that prevailed during 1999–2005.