German economy in triple spin

Teaser: Covid-19 tightens its grip once again on Europe, including Germany, revealing the vulnerability of the German economy.

Tuesday the 13th October, the German ZEW index fell to 56.1 from 77.4 in September, a sharp drop and way below the expectations of around 73. The 400 analysts and institutional investors consulted each month concerning the ZEW index, have conversely become more optimistic about the outlook for the German economy- the latter is quite interesting.

The steep dive in the main ZEW index is significant, and apparently quite surprising, with the main reason stated to be the renewed threat of a hard Brexit, and the Covid-19 once again taking its grid on Europe. I estimate that the extremely high ZEW index reading in September came as a reaction to the positive third quarter, when the Covid-19 infection was on a strong retreat in Europe, which provided relief, and the economies moved forward again.

In my view, the German economy faces three challenges, thus I disagree with this month's belief (based on the ZEW survey) of improved prospects for the German economy. I do not think the German economy is in an upward momentum, like a perfect triple spin jump. On the contrary, the risk that Germany's economy could go into a downward spin intensifies for three reasons.

I agree with the respondents in the ZEW survey that the lurking hard Brexit represents a certain challenge and risk. If the outcome is a hard Brexit, a tariff increase of 10 to 15 pct. on trade between EU and UK must be expected, though it is not the biggest shock German exporters could explore.

A remarkably interesting report from Deloitte in Germany also gives the impression that German companies are no longer deeply concerned about the future prospects in relation to the United Kingdom. A number of companies have simply turned their attention to other markets, but among the 190 German export companies (with a minimum of 100 employees in the UK) that Deloitte surveyed, the UK, as an export market, seems to be in a status quo situation.

Measured in terms of turnover, German exports to the UK have declined since the British EU referendum in June 2016, but this corresponds to approximately the decline in the pound exchange rate during the corresponding period. This has been absorbed by the German export companies, which I see as an indication that German exporters over time also will cope with a new trade tariff of 10 to 15 pct. This is one of several reasons why I do not fear a hard Brexit as much as the respondents to the ZEW survey do.

I argue that the strongest and most basic risk takes origin from before the Covid-19 crisis. We will never know which GDP growth Germany would have had this year without Covid-19, but it already looked sluggish at the beginning of the year. In my view, growth would have ended at a very low level this year, as the Bundesbank's WEI index (a GDP growth early indicator) also indicated at the start of the year, according to the completely flat development (Graphic 1). Although the start of the year might feel like a whole decade ago, some may remember January 29th, when German Economy Minister Peter Altmaier presented the German government's annual economic forecast.

It is by no means to be in hindsight or show similar qualities, but the expectation of a GDP growth of 1.1 pct. for 2020, even before the Covid-19 outbreak in Europe, was far too optimistic for the vast majority of the financial market. My argument in this connection, as well as in 2019, was that the seriousness of the situation was emphasized by the fact that Germany had a historically low unemployment rate, and an economic growth that was dangerously heading towards zero, or just a small plus.

I circle back to this view as I argue that the positive momentum already left the German economy last year. My basic assessment of the effect of Covid-19 is that existing developments from before the Covid-19 crisis are amplified. I argue that this combination is the biggest risk to Germany's economy, namely that an ongoing declining momentum all the way back from 2019 is now flaring up again and even intensified by the crisis. The WEI index provides a clear picture of how growth has been in decline since mid-September. The changes in producer prices (Graphic two) should never be overinterpreted, but they are clearly under pressure, and I assess that this can be partially attributed to lack of demand.

One might be surprised that the classical strong German economy can lose so much momentum, but even a strong economy must be nurtured with reforms and initiatives. Chancellor Angela Merkel is not exactly a warrantor for this, which is also obvious during the Covid-19 crisis. Obviously, the plan is just to get through with well-known tools and support schemes, but the result seems more paralyzed than, for example, the handling in many Asian countries. Therefore, I fully understand the ZEW respondents' concern about the new increase in the Covid-19 cases, simply because many European countries obviously have a harder time dealing with the crisis than many Far Eastern countries have.

It has long been clear that China will end this year with a positive GDP growth, but a number of other Far Eastern countries are now also showing progress again- it confirms once more that the economic world order is constantly changing, and in between, faster or different than expected.

Click here to join our thousands of readers around the globe who receive our financial markets insights for free.