Incoming data on the German economy continues to install confidence to Euro longs. After PMI and ZEW, the positive series was updated by the Ifo report, which indicated an improvement in the prospects for the German economy. In January, the index was 90.2 against 88.6 in December and returned to the levels of mid-2022:
While the drop in the current situation component shows that the economy is definitely still struggling, expectations have continued to improve. Lower wholesale gas prices and reopening of the Chinese economy have bolstered economic confidence. However, the fact that the German economy appears to have escaped the worst does not mean it will now move on to expansion.
The key factors of improvement in fundamental soft and hard data on the EU bloc is warmer winter weather, along with announced governments’ fiscal stimulus packages.
In fact, the German economy has proven to be more resilient despite a long series of crises in 2022 that threatened to plunge it into a deep recession. The reason for this resilience is not so much in the structure of the economy, but in a simple policy recipe that the German government has successfully used over the past 15 years and has refined more recently: fiscal stimulus.
Contrary to popular belief and what the German government has often preached to other European governments, German officials prefer direct fiscal stimulus. This was the case during the financial crisis, during the Covid-19 pandemic, and now in response to the war and the energy crisis. What the German government has perfected during the pandemic and last year’s crisis is the use of large ballpark numbers, hoping that not all of the money will have to be used in the end. During the pandemic, direct fiscal stimulus amounted to more than 10% of GDP. Last year, after several months of hesitation, the government decided on several stimulus packages and price caps that totaled about 8% of GDP. The announcement effect and real money saved the economy from recession, at least for now.
Not falling off a cliff is one thing, but making a strong bounce is quite another. And there are very few signs pointing to a German economic recovery any time soon. First of all, we should not forget that fiscal stimulus over the past three years has stabilized, but not stimulated the economy. Industrial production is still about 5% lower than it was before the pandemic, and GDP returned to its pre-pandemic level only in the third quarter of 2022. Industrial orders have also weakened since early 2022, consumer confidence, despite some recent improvements, is still close to all-time lows, and the loss in purchasing power will continue into 2023.
Like any economy in the Eurozone, the German economy has yet to experience the full impact of the ECB policy tightening. Demand for mortgages had already begun to fall, and, as in previous boom cycles, demand for business loans soon began to fall as well. In short, the German economy will continue to be hit hard by last year’s crises throughout 2023.