The German economy is picking up momentum at a time the UK is losing momentum - does this have implications for the GBP to EUR exchange rate?
- German economy in the midst of a regime change
- Demand to house German refugees to keep domestic demand high going forward
- UK economy is meanwhile in a notable slowdown, but beware of writing-off the UK
- Eurozone growth now at levels higher than pre-crisis peak, but ECB could still cut rates on inflation concerns argue Lloyds
German flash Q1 2016 GDP rose 0.7% q/q, above economist forecasts for a reading of 0.6% ensuring annual growth stands at 2.75%.
This represents a 0.4pp acceleration in growth on the previous quarter.
DESTATIS, Germany’s official statistics body, noted that “positive contributions mainly came from domestic demand.”
“This is in line with our view that the fiscal policy stance became more expansionary due to increased spending on the large number of refugees currently hosted in Germany,” says Olga Tschekassin at Barclays in London.
The data leaves Germany at the top of the growth league in the G7 as the Eurozone’s powerhouse continues to outperform its peers.
There are suggestions that the data may be over exaggerating the underlying strength of the economy, for instance owing to the milder-than-normal winter weather which allowed construction to put in a stronger contribution than would normally be the case at this time of year.
“Such fault-finding misses the point,” counters Dr Andreas Rees, Chief German Economist at UniCredit Research, “even if the weather god had not been on our side the recovery would have gathered pace.”
UniCredit say the German economy is in the midst of a “regime change towards more domestic demand.”
It is noted that Both private consumer expenditures and investment in machinery and equipment continued their recovery.
Capex spending rose for the sixth quarter in a row and German companies seemed to have abandoned their restraint towards investment (and borrowing as corroborated by the latest ECB data).
German Growth to Extend
Looking ahead, the strong growth is forecast to continue.
“We maintain our view that the German economy remains resilient with historically very low unemployment, buoyant domestic demand and a healthy construction sector, which has benefited from a significant rise in housing demand due to the high immigration to Germany,” says Tschekassin.
Barclays believe the growth prints will remain strong in the coming quarters, albeit at a slightly slower pace (Q2 and Q3: 0.5% q/q) as headwinds from tepid global trade and Euro appreciation pose further risks to the German export sector.
“Nevertheless, the continued strength of domestic demand points toward a steady rebalancing of the overly export-reliant German economy,” says Tschekassin.
UniCredit’s Rees is in agreement saying his team stick to their growth forecast of 1.8% for 2016.
“In all probability, there will be a technical setback in the second quarter driven by construction activity but that is it. Only a large shock such as Brexit could endanger the recovery and here especially capex spending of companies. Please note that we expect the UK to remain in the EU,” says Rees.
How Does the UK Compare?
Those who are looking to GDP comparisons to form assumptions on the future of the GBP/EUR rate will be wondering how Germany stacks up against the UK.
The strong German GDP reading of 0.7% for the first quarter stands in contrast to the 0.4% reading delivered by the UK over the same period.
There is therefore not much in it, particularly when we remember the UK’s Q4 2015 reading was revised to an impressive 0.6%.
However, April’s Markit surveys suggested that growth has virtually ground to a halt and other evidence pointing to a softening in activity includes rising unemployment and a slowdown in retail sales growth.
Industrial and manufacturing production for April confirms this sector is also suffering a notable slowdown leading to expectations that the next set of GDP figures will not be as flattering as those we have witnessed in past quarters.
“It has been a very consumer-dependent recovery recently and some of the temporary boost to incomes is now wearing off, while the drag from deficit reduction will increase. Manufacturing is still not in a position to pick up the slack. And the UK’s longstanding problems – weak productivity growth and a large current account deficit – have not been addressed,” says Vicky Redwood at Capital Economics.
HOWEVER, Redwood warns that the recent gloom towards the UK economy is overdone:
“The recent sense of gloom has been overdone. For a start, some of the non-Brexit factors pushing down growth recently – such as the financial market jitters earlier this year – have now abated.
“Meanwhile, worries that consumer spending is about to nose-dive are unwarranted. Interest rates will stay low and inflation will pick up only gradually. In fact, if nominal pay growth reverses some of its recent weakness, as seems likely, consumers’ real pay growth will accelerate this year.”
Going forward we would have to put our money on the German economy when it comes to winning the growth stakes.
That said, post-referendum Britain could well spring some surprises, and in currency markets the only thing that matters is how you beat or miss expectations.
Eurozone Growth Back to pre-Crisis Peak
The strong outturn in Germany has aided overall Eurozone growth to 0.5% for the first quarter of 2016.
The real level of output is now higher than the peak in early 2008 prior to the global financial crisis.
“Consumption is expected to remain a key driver of GDP growth this year, while fiscal policy will also be supportive, largely reflecting expenditures related to the refugee crisis,” says Hann-Ju Ho at Lloyds Commercial Bank.
It is notable that Lloyds do not foresee the European Central Bank standing away from introducing further easing measures on the basis of the uptick in growth.
Inflation remains persistently low having fallen back to -0.2% year-on-year in April and as such remains a threat to the Eurozone's economic outlook.
Firms will be unable to raise prices, ensuring profitability remains under pressure and the productivity of the workforce remains subdued. Therefore earnings will also likely remain under pressure which all points to stagnation.
The ECB had already anticipated the possibility of headline inflation turning negative again and hence will not be greatly surprised by the April CPI outturn. Moreover, ECB President Draghi said that “we have to be patient” in waiting for the impact of policy stimulus measures on inflation.
"Nevertheless, it will be concerned about the decline in core inflation this year, after previous hopeful signs of revival. Further policy easing by the ECB therefore remains on the cards, but June is likely to be too soon," says Lloyds' Ho.