GDP Contraction in Q3 Confirms German Economy in Recession

According to "flash" data from the Federal Statistical Office (FSO), real GDP declined in the third quarter of 2008 by 0.5% quarter-on-quarter (q/q), adjusted for seasonal and calendar factors. This follows a similar contraction of 0.4% q/q in the second quarter and a last strong increase of 1.4% q/q in the first quarter of 2008. Modest upward revisions of 0.1 percentage point were revealed for both the first- and second-quarter GDP figures, which contributed to the greater-than-expected third-quarter decline (the market consensus had been contraction of 0.2% q/q, while a recent indication sourced to the Economic Ministry had mentioned a figure of -0.25% q/q). Year-on-year (y/y) growth, again calendar adjusted, fell from 1.9% in the second quarter to 0.8% in the third. An additional working day in the quarter compared with a year earlier provided for unadjusted annual growth of 1.3% in the third quarter, but this was down even more sharply from 3.3% y/y in the second quarter, which boasted three additional working days compared with the same period of 2007. The cyclical peak had been close to 4% in late 2006, when the looming value-added tax (VAT) hike had led to purchases being brought forward.

Net Exports Provide Main Dampening Impulse to Quarterly Growth in Q3

Detailed data, notably for the individual expenditure components, will not be made available until the forthcoming release on 25 November. Nevertheless, the qualitative information provided by the FSO allows the conclusion that net exports were the key negative contributor in the third quarter, reversing the second-quarter developments. This was for the most part due to a fresh surge in imports, although weakening exports also played a role. Increasing real imports are related at least in part to the boosting impact of markedly falling import prices, both directly and by providing an incentive to producers to stock up on now less costly inputs from abroad. Furthermore, domestic demand growth was mildly positive, partly due to increased real purchasing power, thus supporting imports from this side as well. Exports, which had held up quite well in the face of the global financial-market turbulence and a strengthening euro until early 2008, have in recent months increasingly succumbed to the pressures of slowing global demand. Indeed, this pattern has already been indicated by the monthly merchandise trade data, and the purchasing managers' index (PMI) sub-index for export orders fell markedly further during the third quarter and indeed also in October, reaching a 12-year and thus series low in that month.

Domestic Demand Recovers from Q2 Dip

Based on the rough indications provided with the "flash" data, key domestic demand components provided mild positive contributions in the third quarter, notably private and public consumption. In addition, increasing inventories unwound their decline in the preceding quarter and therefore boosted GDP. This is related to the marked decline in commodity prices, including energy in recent months, which provides an incentive to stock up on raw materials. Producers had held back on replenishing their supplies during the second quarter because of the very high price levels. Meanwhile, the FSO made no explicit mention of developments for investment, be it in equipment or construction. This does suggest that q/q changes were not massive, and rather that there was limited movement compared with the second quarter. Nevertheless, based on weakening monthly production and orders data in the manufacturing sector, investment in equipment is likely to have slipped, whereas more resilient construction orders suggest that this sector remained roughly stable. Orders growth among VDMA firms, which produce mostly investment goods such as machinery and plants and have been a backbone of Germany's economic recovery since 2005, managed to return to positive territory in September, rising by 2%, following declines averaging 9% y/y during May-August. This supports the notion that investment has not plunged sharply as yet. With regard to private consumption, retail sales data were indeed not that weak during the third quarter, although a spike in August was duly unwound in September. The marked softening of inflation since mid-July has had a supportive impact via increased real purchasing power, whereas fears of a future increase in unemployment due to the current economic crisis have not played a major role as yet. This holds all the more true in view of ongoing wage settlements at solid levels of around 4% in the recent past.

Calendar Effects Boost Q3 Annual Growth Rate

There was an additional working day in the third quarter compared with the year-ago period. This explains the difference between the unadjusted y/y growth rate of 1.3% and the adjusted figure of only 0.8% (down from 1.9% in the second quarter). The gap had been even larger in the second quarter, when there had been three additional working days. Looking ahead, there will be only marginal differences between adjusted and unadjusted y/y rates in the final quarter of 2008 and first quarter of 2009.

Outlook and Implications

Negative growth in the second quarter had largely been a technical reaction to very strong first-quarter growth that owed to a large seasonal one-off effect from construction investment, whereas the weakness in the third quarter was mostly a reflection of the underlying downward trend linked to the financial-market crisis and the dampening impact this is having on global growth forces. The about-turn of inflation during the third quarter towards softer rates, along with still-robust nominal wage settlements, is a supportive factor for private consumption but cannot compensate for the massive downward impulses affecting exports and investment.

The relative resilience of the German economy observed until early 2008 is now history, as the ongoing decline of foreign orders in particular is leaving its mark. Exports will deteriorate further until at least mid-2009 and quite possibly throughout the whole of next year, notwithstanding a now much softer euro and Germany's advantages in terms of competitiveness compared with most of its Eurozone partners (it has a favourable product mix geared towards investment goods still required by major emerging economies in Eastern Europe and the Far East). The key determinant for German export volumes continues to be demand levels among its trading partners, and these will be very weak for much of 2009, not only in the United States but also within the Eurozone. Together with relatively resilient imports—as German consumers do not need to cut back as much as elsewhere—the external contribution to GDP growth will therefore become neutral or even negative. Equipment spending will be deeply negative in 2009, mainly as uncertainty about the timing of a recovery in global demand leads to investment projects being shelved. In the manufacturing sector, such investment may easily decline to the tune of 6% or even 8% compared with 2008. These negative tendencies have been captured in releases up to October of leading indicators such as the Ifo expectations index or PMI data.