German Q3 GDP Recovery Driven by Major Inventory Rebound

According to detailed data from the Federal Statistical Office (FSO), German real GDP growth in the third quarter of 2009 increased 0.7% quarter-on-quarter (q/q), adjusted for seasonal and calendar factors. This confirms the preliminary figure released on 13 November and follows growth of 0.4% q/q in the second quarter. Nevertheless, the recovery in the two most recent quarters is put into perspective by the fact that the economy underwent its sharpest contraction in post-war history during the period from the second quarter of 2008 until the first quarter of 2009 (when there was a cumulative decline of 6.9%). The year-on-year (y/y) rate of contraction, again calendar adjusted, had reached a trough of 6.7% in the first quarter of this year and has now improved from 5.8% in the second quarter to 4.8% in the third. There was only a minimal working-day effect in the third quarter, in contrast to the major dampening effect in the second quarter, meaning that the unadjusted annual rate of contraction improved much more sharply from an all-time record of 7.0% to 4.7%. The cyclical peak had been close to growth of 4% y/y in late 2006, when the looming value-added tax (VAT) hike had led to purchases being brought forward.

Net Exports Fail to Support Growth

The breakdown by individual expenditure component shows that, contrary to the impression given by the FSO in comments accompanying the "flash" release of 13 November, net exports dampened GDP growth in the third quarter. The large boost observed in the second quarter—after three quarters in which net exports had had a depressing impact—could not be sustained despite a welcome return by exports to positive growth (3.4% q/q) because of a sharp reversal of fortunes for imports. These jumped by 5.0% q/q, following contraction of 5.4% in the second quarter and before that two quarters of declines of a similar magnitude. Net exports therefore subtracted 0.5 percentage point from quarterly GDP growth in the third quarter, contrasting with a positive contribution of 1.9 percentage points during the second quarter. The dampening impact was far smaller than in the fourth quarter of 2008 (-2.1 percentage points) and the first quarter of 2009 (-2.5 percentage points), however.

The rebound in gross exports was down to the recent recovery of global demand, and the swing for imports was related to a fresh build-up of depleted inventories and the fact that many exporters require imported inputs for their manufactured goods. The tendency to replenish inventories has been encouraged by the low import price levels of mid-2009. Looking ahead, some of the factors that boosted imports in the third quarter are likely to prove transitory, such as inventory restocking, whereas exports should recover even more strongly in the coming months. Thus the external sector should become an important contributor to German GDP growth again from the fourth quarter onwards.

These developments had already been indicated by the monthly merchandise trade data, although these nominal data understated the relatively greater increase in real imports because of their larger price decline. Nevertheless, the purchasing managers' index (PMI) sub-index for export orders, following an all-time low in December 2008, has been recovering with growing momentum between March and November 2009, auguring well for exports in the fourth quarter of this year and first quarter of 2010. This is closely linked to rebounding world trade, which German exporters stand to profit from thanks to their competitive position—notwithstanding the restraining influence of the recent appreciation of the euro. Some delay is implied by that fact that Germany's export strength lies in areas related to investment (notably plants and machinery), which will react more slowly than global demand for consumer goods.

Domestic Demand Components Reverse Roles

The third quarter was characterised by a huge jump in inventories, boosting GDP by 1.5 percentage points, drowning out all other factors. Overall domestic demand thus contributed 1.2 percentage points to quarterly GDP growth, but this implies that domestic demand minus inventories subtracted 0.3 percentage point, contrasting with a gain of 0.6 percentage point in the second quarter and returning to the contractions seen in the two previous quarters. The rebound in inventories unwound the bulk of the huge second-quarter decline, when companies strenuously attempted to save costs by delivering goods from existing stocks instead of current production. In the third quarter, improving demand levels enabled and even forced many companies to raise both production and inventory levels.

Among the domestic demand components, private consumption was the biggest dampening factor (down 0.9% q/q, subtracting 0.5 percentage point from GDP, whereas government consumption was broadly flat (up 0.1% q/q, equating to a 0.0% contribution). Consumer spending was hurt by waning effects from the car scrappage subsidy that expired at the start of September, and apparently the boost to purchasing power from falling inflation also no longer had a stimulating impact. Fixed investment was an encouraging element after its precipitous drop at the beginning of 2009, increasing 1.3% q/q and thus boosting GDP growth by 0.2 percentage point. This stemmed from both equipment spending (up 0.8% q/q, equating to a positive impact of 0.1 percentage point) and construction investment (up 1.5% q/q, 0.2-percentage-point impact). This was observed despite still below-average demand and capacity utilisation levels and tight credit conditions.

Rising unemployment will become an increasing concern for consumers in the coming quarters, whereas government consumption will remain a stabilising element for now (this may change from 2011 onwards when fiscal consolidation needs become more pressing). On the investment front, public investment should remain relatively strong in 2010 thanks to the impact of the economic stimulus packages, but private investment has only bottomed out and will not rebound strongly ahead of 2011.

Outlook and Implications

Germany's economic recovery during the two last quarters is encouraging but its significance must not be overstated. To a considerable degree this reflects a natural turnaround for inventories as orders have improved, thus removing the deep gloom and doom observed among companies in early 2009. Nevertheless, the underlying investment trend will remain rather flat in 2010, given that capacity utilisation levels will continue to be below long-term averages for several quarters yet. Furthermore, the lagged boosting impact of the recession on unemployment will hit private consumption during much of 2010.

On the bright side, the revival of global demand should increasingly strengthen exports, whereas imports—once the boost related to a rebuilding of stocks has run its course—will be relatively weaker because of soft domestic demand. The stronger euro may temper the export rebound, but the key influence, as in the past, is the momentum of growth in Germany's export destinations. Although the prospects here are relatively encouraging at present, it needs to be added that the levels of 2007 are unlikely to be reached again before 2012 or 2013. Other supportive factors for German growth in the quarters ahead are persistently soft inflation (although headline rates will rise to around 1.0% as a result of energy price base effects), pent-up consumer demand due to very restrained spending since 2001, and ongoing monetary and fiscal stimulus measures. The latter pertains to additional government investment in infrastructure and higher child support payments for consumers.

On balance, Germany's reasonably benign economic outlook for 2010 rests in particular on the competitive advantage of its export industry, notably compared with most of its Eurozone partners. The steady improvement of leading indicators such as the Ifo and PMI surveys since around March suggests that the current economic recovery is reasonably strongly underpinned. Persistent financial sector problems and the need to unwind fiscal stimulus programmes worldwide by 2011 at the latest nevertheless suggest that it will take several years before the economic activity levels of 2007 are reached anew. In its November detailed forecast, IHS Global Insight predicts GDP contraction of 4.8% in 2009 and a moderate recovery to growth of 1.5% in 2010. It will probably be late 2010 before a sustained economic recovery emerges, and a temporary setback during much of 2010—following the completion of the current inventory adjustment—remains most likely. We expect the European Central Bank to keep monetary policy soft well into 2010, given that a return to some degree of "normality" in credit conditions is still some way off.