Germany – waiting for better times

German economy remains weak...

In recent weeks, there has been a series of bad news from the German economy. It shrank slightly in the second quarter, the start of the third quarter was very weak with a 2.4% drop in industrial production, and the renewed decline in sentiment indicators gives little hope that the figures will quickly improve significantly.

... brings structural problems into focus, ...

As a result, Germany's economic output in the second half of the year is not expected to be any higher than it was before the pandemic. In view of this stagnation, which has lasted for five years now – if we disregard the temporary slump caused by the coronavirus pandemic – more and more people are becoming convinced that this weak development has structural reasons. In fact, studies show that Germany has become less and less attractive as a business location in recent years compared to other countries.

... which are also unlikely to be overcome quickly

In response to the discussion about Germany's weaknesses as a business location, the German government has launched a "Growth Initiative". Many of its 49 items certainly point in the right direction. However, it is uncertain whether all of them will actually be implemented, and from today's perspective it is difficult to say whether they will noticeably boost growth. Moreover, experience shows that such structural measures take effect only with a significant lag. So there is much to suggest that these measures will not provide much of a boost to the economy, at least not this year and for much of next year.

However, the burden of monetary policy is easing...

However, the long-lasting weakness of the German economy cannot be attributed to these structural factors alone, but also to other adverse factors. The first of these is monetary policy, which was tightened massively in 2022 and 2023, not only in the eurozone but also in all other western industrialized countries. A study by the ECB shows that the effect of monetary policy on the more capital-intensive manufacturing sector is significantly greater than on services, so that the German economy, given the rather high share of manufacturing in its value added, is likely to have suffered more from the interest rate hikes than most other economies in the euro area. Furthermore, German manufacturing is particularly strong in the capital goods sector, where demand at home and abroad has been hit especially hard by the less favorable financing conditions.

However, the headwind from monetary policy should gradually ease now. This is because the vast majority of interest rate hikes were implemented more than a year ago, so the economy is likely to have increasingly adjusted to the higher interest rate level. However, a rapid turnaround is hardly to be expected. For example, sentiment indicators have recently fallen again. Furthermore, in the construction sector – or, more precisely, in the building construction segment – production has not yet been fully adjusted to the significantly lower level of incoming orders. In the coming year, however, the burden of higher interest rates is likely to ease, especially since the key interest rate cuts will gradually start to have a positive effect on the economy from the middle of the year.

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