The German economy has recovered more quickly than expected from the cyclical lull in the middle of last year and has returned to a growth path that is underpinned by both domestic and foreign demand. "Domestic economic activity is benefitting from the favourable labour market situation and the substantial income increases," commented Jens Weidmann, President of the Deutsche Bundesbank, on the Bundesbank's latest semi-annual projection. "Although foreign trade is currently being hampered by dampening global dynamics, it is simultaneously being buoyed by the euro’s depreciation and the strengthening cyclical recovery in the euro area," Mr Weidmann remarked. He added that the world economy was likely to regain momentum.

Aggregate output

Under these conditions, the Bundesbank's economists expect Germany’s real gross domestic product (GDP) to grow by 1.7% this year, 1.8% in 2016 and 1.5% in 2017. After calendar adjustment, this equates to expansion rates of 1.5% in 2015 and 1.7% in both 2016 and 2017. As the expected increases are above the estimated growth rate in potential output of 1.2% per year, aggregate capacity utilisation should, according to the Bundesbank's experts, rise markedly and considerably exceed the normal level by the end of the forecast horizon. This means that labour market reserves will be mobilised and wages will rise more strongly in the medium term. Against this backdrop, general government is set to continue posting surpluses of around ½% of GDP. The Bundesbank economists point out that the economic upturn and the ongoing decline in interest expenditure are masking the generally expansionary stance of fiscal policy.

Price developments

According to the Bundesbank projection, consumer price inflation is likely to accelerate. Initially, this will reflect the euro’s depreciation against other major currencies, while the upward pressure on domestic costs should increasingly make itself felt later. The Bundesbank's economists forecast that inflation, as measured by the Harmonised Index of Consumer Prices (HICP), could rise from 0.5% this year to 1.8% next year and 2.2% in 2017. Excluding energy, HICP inflation would climb from 1.2% in 2015 to 2.2% in 2017.

Risk assessment

Compared with the December 2014 projection, expectations for economic growth for the current year, in particular, have been raised significantly, while the projection for inflation has been pared back considerably. "The key factor behind the subdued inflation outlook is the sharp drop in crude oil prices," Bundesbank President Jens Weidmann said. Crude oil prices are expected to rise only slightly and exchange rates to remain unchanged over the forecast period. If exchange rates were to rise strongly, this would produce downside risks to the economy. In the Bundesbank's view, further external risks are posed by the vulnerabilities of several emerging market economies and by geopolitical tensions. Referring to the economic recovery in the euro area, Mr Weidmann cautioned that the danger of a setback had not yet been banished. "Moreover, on the domestic front, growing labour market shortages represent a supply-side risk to economic growth, and they could also be reflected in increased price pressures," the Bundesbank President explained.