German economy, will the slide continue?

• Weakening global industrial demand weighs on Germany’s manufacturing sector
• Inflation and business climate take a hit with broader signs continuing to be subdued
• Future growth prospects skewed heavily towards external demand

Germany, which is the largest economy in Europe is facing a fresh round of downward spiral if one looks at the major economic indicators on manufacturing, business sentiment, employment, exports and inflation among others. Though the other major economic partners in the EU, Italy and France are also not performing well, with Italy moving into the recession (Dec. 2018), whereas France is facing civilian backlash along with economic deceleration. Germany, which is the biggest in the region is spelling more troubles for one of the world’s largest economic groups.

German manufacturing PMI data published on the 1^st of April cast a dark shadow on the already weakening economic scenario, with the reading standing at 44.1, which is at its lowest levels since July 2012 and contracted for the third month in a row. The PMI data below 50 indicates contraction in the sector, this was even lower than the flash manufacturing PMI, which came in at 44.7 during the second last week of March. Moreover, the pace of decline in the PMI has also been at a record rate too; marking its biggest point wise fall in the last six years. The manufacturing sector, which technically shares around 20% weight in the overall economy is sentimentally favoured to be highly critical, as the majority portion of the sector is attached to exports. A consistently weakening manufacturing activity in Germany suggests a slowdown in consumption in other parts of the world. This can be ascertained with the new order data under the PMI head, which has come in at its weakest levels in nearly a decade. There are signs that a continually weakening manufacturing segment is starting to take the hit on the employment numbers locally. The latest PMI data shows payroll numbers most likely fell for the first time in the last three years. The industrial production, which comes at a lag of two months, followed a near similar trajectory, with a YoY growth coming into negative for two out of the last three periods (Nov. 2018-Jan. 2019). Manufacturing output has been decelerating for over a year now before recording negative growth in Nov. and the latest in Jan. 2019.

Earlier, the IFO institute which publishes the report on business and economic confidence related to current and future expectations for Germany suggested a marginal improvement in economic and business confidence for the economy as per its March report, though the overall theme continues to be on the downside. The IFO Business Index inched higher to 99.6 in March from 98.7 during February, whereas another major economic survey from ZEW also portrayed moderation against extreme negativism towards the overall economy. Amelioration in both the major economic gauges hints that Germany’s economic situation might not be as bad as anticipated earlier.

Looking at the other major indicators, the inflation data as seen through the CPI and PPI reading is also rendering softness. While PPI has been highly mercurial during the last 6 to 8 quarters, circuitously portraying the issues over the manufacturing and industrial sector in the economy, CPI was stable near the targeted 2% mark for a major part of 2018, especially the first half of the year before sliding lower and standing at 1.3% as per the latest report for the month of Feb. A near similar case was seen for the EU area, wherein falling economic and business climate, low inflation and subdued economic developments on either side of the Atlantic and Pacific forced the ECB to provide fresh policy support to the region. In its latest meeting during March, the central bank stated that it would continue with its ultra-low interest rate policy at least till the end of 2019, pushing the expectations on its first-rate hike since 2011 to somewhere during the second half of 2020, as against Q1 2020 earlier. The bank trimmed economic growth forecast for the region considering the developments in the domestic and external environment. Additionally, the central bank said, ‘a new series of quarterly targeted longer-term refinancing operations (TLTRO-III) will be launched, starting in September 2019 and ending in March 2021, each with maturity of two years. The central bank which started with its first LTRO program in 2014 is now planning to launch the third tranche of the same, boosting banks with capital so that they can forward this to corporates and institutions, eventually fuelling a fresh business cycle in the ailing economy.

The market expectations for the EU region and particularly for the German economy have become so negative over the past few months that yields for the German government bonds or the bunds moved into negative territory. This can be backed by the fact that uncertain times drive institutions, investors and traders alike towards the safety of government bonds, wherein they are ready to get even lesser than what they have invested, however, they have the comfort of safety on the capital. The German government recently sold its 10-year bonds at a negative yield of 0.05% as per the data from the German Finance Agency.

One can say that things have not moved much for Europe’s largest economy during the last few quarters, wherein it was even hooked to move into recession in Q4 2018, though it just managed to avoid the same by posting a flat growth. Germany recorded a 0% growth in Dec. quarter (QoQ comparison) and just averted recession after the -0.2% growth in the Jun.-Sep. quarter on a constant currency basis. The full year growth was down with the economy posting the worst performance since the downturn in 2013. Fears over subdued growth domestically, which was mainly led by the automobile sector’s fallout, export slowdown due to the US-China trade war, overhang due to long-pending Brexit resolution and persistent fall in the Chinese economy weighed on the German economy. The US-China trade issues and subdued Chinese growth took a toll on the overall trade data for Germany, which saw its 2018 trade surplus sliding by 8% to USD 228 Bn against USD 248 Bn in the previous year. Notably, a fall in the surplus is after accounting for the 4.5% depreciation in the Euro during the last year, which averaged 1.18 (daily price) against the USD as compared to 1.13 in 2017. The trade numbers are expected to further move lower during the current year as the major global emerging and developed economies face growth concerns after a steady performance over the last 2-3 years.

Amid a host of negativity from the external environment, some local data points have provided solace until now, like the service sector data, which broadly stood stable alongside the employment and retail sales numbers for Germany. Notwithstanding the fact that the service sector drives a major portion of the economy, manufacturing growth and sentiment continues to be critical as extended weakness; herein might start affecting the normalisation in services growth. Televisory believe that the worst in terms of economic contraction might be over for the German economy with fears of recession taking a back seat, though the overall economy is likely to tread on a cautious path. Tough times are ahead for the policymakers (ECB and the EC members) along with the local parliamentarians, who would have to balance the support on the fiscal and monetary policy to at-least take care of the internal factors. Externally, a ray of hope came in the form of the March Chinese and the US manufacturing PMI (both government and private data), which improved for the former and stood stable to positive for the latter depicting some grip coming back for the ailing sector. But still, it would be too early to suggest that optimism has come back into the broader markets globally and for Germany based on a few data points. The ECB and other German economic wings have already trimmed GDP growth forecasts to just near 0.6% for 2019 as against 1.1% earlier, though further downside risks exist amid subdued growth in China and concerns over hard landing on the Brexit where deadline after deadline is being revised by the UK policymakers. Germany would be heavily dependent on the cues and developments in China and the US over the next few quarters, wherein any major movement in those economies in either direction would dictate the growth for Europe’s bellwether. The macro view continues to be cautiously negative for the next few quarters.