UK-German Trade Slowdown to Deliver 0.7% Hit to German GDP say Barclays

Uncertainty stemming from Brexit and a stronger Euro will dent German growth as the country's exports to Britain slow and domestic consumer confidence takes a knock.

The Eurozone’s largest economy is forecast to suffer a notable hit to growth thanks to Brexit-inspired consumer uncertainty and the strengthening of the Euro exchange rate argue Barclays.

With some data now behind us Barclays have taken the chance to examine the impact of a Brexit-induced UK slowdown on Germany through international trade, finance, business sentiment and migration.

Germany is the largest economy in the EU, accounting for 28% of the euro area’s output in 2015.

It has extensive trade linkages with its partners in the region, with exports representing roughly 50% of its GDP, of which 58% are exported to EU countries and 7.5% to the UK.

Data shows that Germany’s bilateral current account surplus with the UK amounts to 1.7% of German GDP and 20.4% of the total surplus.

This is mostly the result of a trade balance surplus, with the income balance contributing little.

The income balance would be the foreign exchange inflows received on Germany’s investments in the UK.

The claims of German banks on UK counterparties more than halved between 2007 and 2015, while FDI is a relatively small exposure.

Therefore, the trade of goods and services with Britain matters for Germany.

Survey evidence shows that, on balance, 28% of German households believe Brexit to be bad for the German economy. This makes sentiment a powerful, yet difficult to quantify, transmission channel.

The ZEW Indicator of Economic Sentiment, a measure compiled by the ZEW think-tank, fell by 26 points to minus 6.8 points in July — the lowest reading since late 2012.

“Uncertainty about the vote’s consequences for the German economy is largely responsible for the substantial decline in economic sentiment,” said Achim Wambach, the president of ZEW.

“In particular, concerns about the export prospects and the stability of the European banking and financial system are likely to be a burden on the economic outlook,” notes Wambach.

Barclays argue that end of free movement following Brexit will likely have a greater effect on Germans in the UK, who make up close to 4% of all UK migrants and outnumber the British in Germany threefold.

UK Recession =  A Hit to German Growth

Historically, UK recessions and growth slowdowns have coincided with a decline in Germany’s bilateral trade with the UK.

Barclays' UK economics team expects a significant UK growth slowdown in 2016 and a mild recession in 2017 as a consequence of the Brexit decision, as uncertainty will remain high until a new agreement is negotiated.

These developments will impact the UK’s economic relations with its trading partners, and foremost with its most important one – Germany.

Barclays have deployed an econometric (VAR) model to examine a number of scenarios and better understand the Brexit consequences for the bilateral trade relationship.

“Overall, our baseline scenario, conditioned on a GBPEUR exchange rate of 1.15 and stagnation in UK domestic demand, suggests that the trade balance deficit will shrink from -2.16% in Q1 2016 to about -1% in Q4 2017,” says Olga Tschekassin at Barclays.

Tschekassin says an adjustment of this size would mechanically reduce German GDP by 0.7% by the end of 2017.

To avoid this adjustment, domestic demand would need to keep growing at 0.8% per quarter and GBP/EUR appreciate back to 1.25.