Q1 GDP Data Signals Broad-Based German Economic Recovery

According to detailed data from the Federal Statistical Office (FSO), real GDP growth in the first quarter of 2006 was 0.4% quarter-on-quarter (q/q), adjusted for seasonal and calendar factors. This confirms the preliminary figure released on 11 May, and follows stagnation in the fourth quarter of 2005, but average growth of slightly more than 0.5% q/q in the first three quarters of last year. In calendar-unadjusted terms, real year-on-year (y/y) growth in the first quarter of 2006 was 2.9%, up sharply from 1% in the fourth quarter of 2005 and 1.5% in the third quarter. This latest jump owes largely to major calendar differences between the first quarters of 2005 and 2006, however. Adjusted for working-day effects, there was indeed a slight weakening of growth to 1.4% y/y, from 1.7% y/y in the fourth quarter of 2005 and 1.6% in the third quarter. Conversely, the first quarter of 2006 suffered from an even harsher winter than in 2005 and probably also a dampening effect from the fact that Easter fell in April this year.

All Sectors Apart From Construction Contribute to Q1 Growth

The breakdown by individual expenditure component that is now available shows that net exports returned to a positive contribution to quarterly growth, adding 0.3 percentage point to GDP after subtracting 0.2 percentage point in the fourth quarter of 2005. The improvement in the first quarter occurred even though imports of goods and services grew more sharply than expected, by 4.5% q/q. Export growth narrowly outpaced import growth, though, at 4.6% q/q, and this, along with higher levels of exports than imports, provided for the net boost to GDP.

In essence, exports benefited from the same factors that were at play throughout most of 2005: the ongoing strength of global demand, the persistence of a relatively weak euro, and improved price competitiveness following cost/wage reductions in recent years. Furthermore, many German goods (notably plants and machinery) are particularly sought-after among oil-producing countries which are flush with funds due to the high oil prices. Meanwhile, first-quarter imports were boosted by rising domestic demand, both from investors and consumers. By contrast, inventories, which had boosted GDP by 0.7 percentage point in the fourth quarter of 2005 - as companies tried to take advantage of temporarily lower prices for oil and some other commodities and/or to avert supply bottlenecks - slipped slightly to have a 0.2-percentage-point dampening impact on GDP).

Private consumption corrected its fourth-quarter 2005 dip of 0.5% q/q in the first quarter of 2006, increasing 0.6% q/q. Fairly weak retail sales data in February and March had not signalled this quite robust first-quarter result, meaning that much of it is explained by a technical correction to the overly soft fourth-quarter consumption figure. Nevertheless, improved consumer confidence should translate into satisfactory consumer spending in the second quarter, notwithstanding ongoing oil-price concerns. This is also supported by the clearer domestic political outlook at present, which reduces the tendency towards a wait-and-see attitude.

Public consumption similarly rebounded in the first quarter, though at 0.6% q/q it failed to make up for the marked drop of 1.6% q/q in the fourth quarter of 2005. That said, the dip in late 2005 also has to be seen against the background of the surprisingly firm quarterly gains of 0.5%, 1.5%, and 0.4% in the first three quarters of 2005. Public consumption is thus still broadly stagnating at levels seen in 2000, reflecting the ongoing, albeit slightly diminished strain on public budgets and efforts at deficit reduction.

Investment posted sharply diverging developments. Investment in construction plunged by 3% q/q after gains of 1.6% and 0.9% q/q in the third and fourth quarters of 2005, respectively. Since construction orders actually showed a strengthening trend according to the available data until February, the only explanation is that the long and severe winter delayed projects until the second quarter. In contrast, investment in equipment rebounded again (up 2.2% q/q, after a rise of 0.1% q/q in the fourth quarter of 2005). This development had already been suggested by the introduction of improved depreciation schedules at the start of 2006 (valid until end-2007). The ‘other investment’ category, including for instance licence rights, gained 1.6% q/q.

Overall domestic demand, which had contracted in the first quarter of 2005 (by 0.6% q/q) and then posted increases of 0.8%, 0.5%, and 0.2% q/q in the three latter quarters of 2005, displayed growth of just 0.1% q/q in the first quarter of 2006. This fairly weak result was mainly due to the weather-related dip in construction, but the swing towards a negative impact from inventory changes (down 0.2%) also played a role. Domestic demand excluding inventories, which had fallen from a rise of around 0.5% q/q in the second and third quarters of 2005 to a 0.5% q/q drop in the final quarter, thus recovered to growth of 0.3% q/q. Looking ahead, this is likely to strengthen further in the second quarter, as consumption and investment in equipment broadly maintain the activity levels of early 2006 while the building sector rebounds. In sum, the picture of underlying improvement has not been altered by first-quarter weakness of the headline figure for domestic demand.

Calendar Effects Likely Dampened Adjusted Data to Some Extent

The late timing of Easter this year (in mid-April) likely led to a fairly significant underestimation of underlying growth momentum in the first quarter. The impact of this calendar effect on the statistics was probably exacerbated by the above-average severity of winter weather, notably in March. The absence of Easter in March led to the addition of two working days in the month this year (alongside a third day elsewhere in the quarter), which the calendar adjustment is meant to correct for. This adjustment may have overly dampened measured growth, however, as private consumption related to Easter still largely took place in April and not in March this year. It is therefore most likely that second-quarter growth, when the calendar adjustment leads to a boost to compensate for the missing working days, will show a large jump that cannot be explained by developments in the second quarter alone.

Outlook and Implications

Global Insight has previously argued that third-quarter 2005 GDP growth (0.6% q/q) was an adequate reflection of underlying developments, whereas stagnating growth in the fourth quarter was hurt by surging imports and very weak private and public consumption (the latter also due to temporary political uncertainty after the elections). In spite of very encouraging monthly indicators (notably but not exclusively from business and consumer confidence surveys), the first-quarter 2006 results have shown only a moderate rebound. This weaker-than-expected outcome can be attributed to a fairly significant degree to the impact of a long winter and the calendar effects related to Easter falling into April this year. Accordingly, technical rebounds linked to delayed investment in construction and private consumption should boost quarterly GDP growth in the second quarter of 2006 to well above 0.5%, possibly even close to 1%. This view is supported by the fact that even in mid-May there is no near-term weakening of global demand in sight, and domestic demand is becoming more broad-based at present. The expected second-quarter rebound may still not be sufficient to uphold Global Insight’s May interim forecast for 2006 GDP growth of 2% (equal to 1.8% unadjusted), due to the weaker-than-expected results in the first quarter. It is nonetheless not advisable to lower forecasts to any significant extent. It should be noted separately that an upward revision to second-quarter 2005 growth has lifted average growth in 2005 from 0.9% to 1% (unadjusted) and from 1.1% to 1.2% (adjusted). For the remainder of 2006, two factors – the football World Cup (June/July) and the value-added tax (VAT) hike scheduled for January 2007 - remain in place to support private consumption.