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Economic Perspective 7/28/2022

Germany: a model to be revised

ODDO BHF5 Minutes

In the spring, the German economy was just on the verge of recession. Since then, according to various business climate surveys, it has made… a step forward. A contraction of activity seems unavoidable. Its duration and extent will depend on the developments of the energy crisis. Germany is exposed to the risk of a gas shortage, the intensity of which depends mainly on two factors, one geopolitical (the magnitude of Russian gas shutoff), the other technical (the diversification via other gas suppliers and other source of energy). In the longer term, Germany's growth model is being called into question.

 

Recession, no longer a question of if, but when and how far

As soon as the war in Ukraine began, the business climate in Europe, and especially in Germany1, began to weaken. At the time, it was difficult to say whether this was just a one-off reaction to a shock of uncertainty - perhaps an overreaction that could be quickly reversed - or the start of a downturn in the economic cycle. Five months later, the scenario of a downturn is now well established.

 

Unlike the 2020 recession, activity was not brought to a sudden halt by the war in Ukraine, except in the automotive sector which was deprived of essential components. At the same time, the service sectors have benefited from the lifting of health restrictions, more or less compensating for the deterioration in other sectors (chart lhs). The catch-up in services is now behind us. Up to now, the Bundesbank's weekly activity indicator describes an economy that is roughly stagnant, but not yet experiencing a sharp correction. However, the outlook for activity has been revised down to a degree comparable to the shock of the pandemic, judging by the IFO survey (chart rhs). No sector has been spared. The PMI survey sends a similar signal: in July, the composite output index fell into the “recession zone”, to its lowest level (excluding the pandemic) since the end of 2012.


 

The direct cause of the fall in business confidence is the ongoing energy crisis, which Vladimir Putin seems to be modulating to suit his interests2. From the point of view of the Russian authorities, a total cut-off of gas deliveries is not necessarily desirable because it would reduce export revenues and lose leverage in the tussle with the EU. To inflict maximum pain on Europe, reduced and disrupted deliveries are a more effective way of creating uncertainty and stirring up divisions between countries. This can be seen in the rather lukewarm initial reaction to the Commission's proposal to uniformly reduce gas demand by 15% in the EU. With some Schadenfreude, several countries felt that they did not have to make such an effort to address a problem that primarily affects Germany. This is a short-sighted position, but one that is attributable to the memory of the sovereign debt crises of the past decade. At that time, it was Germany that imposed fiscal austerity measures on southern Europe. A political agreement was eventually reached on this plan. It would be mistaken to think that the rest of the EU will not be affected if the German economy continues to weaken.

 

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