Economic activity in Germany is likely to remain very subdued through the final quarter of 2019 and the first quarter of 2020, just as in the preceding quarters. “However, as things currently stand, there is no reason to expect that Germany will slide into recession,” the Bundesbank states in its latest forecast. In fact, the Bank’s experts have identified tentative signs that the German economy will gradually be able to emerge from its current lull. Admittedly, employment growth and, by extension, the rise in disposable income will probably decline substantially over the projection horizon up to 2022, curbing increases in domestic demand. Nevertheless, Germany’s supportive fiscal policy and its highly accommodative monetary policy are set to have a bolstering effect. In addition, the continued weak growth in exports is likely to recover gradually over the course of 2020. “These developments should see industry pick up and the two-speed nature of Germany’s economy become less pronounced,” Bundesbank President Jens Weidmann commented with regard to the new macroeconomic forecast. Economic growth has been driven chiefly by its domestically oriented sectors in recent times, while the export-oriented industrial sector has flagged.

Stronger increase in economic growth

For the current year and the year ahead, the Bundesbank projects calendar-adjusted economic growth of only 0.5% and 0.6%, respectively. In the subsequent two years, gross domestic product (GDP) is set to see distinctly stronger growth of 1.4%. The German economy could thus return to growth at rates close to those for potential output once it has overcome the lull. However, as before, the downside risks predominate for economic expansion. “External sources of risk persist, which could exacerbate or prolong the downturn in the industrial sector,” Mr Weidmann said.

Considerably higher inflation rates expected

The inflation rate as measured by the Harmonised Index of Consumer Prices (HICP) decreased significantly this year to 1.4% at present, down from 1.9% in 2018. In 2020, the Bank’s experts predict that it will sink slightly further to 1.3% on account of falling energy prices. Inflation is subsequently set to pick up considerably as of 2021. Primarily in response to the climate measures recently adopted, energy prices would then increase significantly, according to the report, which continues: “Price dynamics in Germany are thus expected to remain higher than those in the other euro area countries until the end of the projection horizon.”

Climate Package will influence growth and inflation

The Climate Package passed by the Bundestag in mid-November 2019 contains measures which will affect consumer prices and economic growth. In particular, the introduction of CO₂ emissions in the areas of building heating and transport is expected to have a marked impact on the inflation rate. Beginning in 2021, the new legislation will require enterprises selling heating fuel and fuel for vehicles to purchase allowances for CO₂ emissions. These will initially be sold at a fixed price of €10 per tonne of CO₂, which will be increased to €35 per tonne of CO₂ in the following years up to 2025. After that, the price will be dictated by the market.

The introduction of such allowances will at first have a direct impact on consumer prices. Assuming that the enterprises pass on mark-ups to the consumer level in full, the Bundesbank’s calculations indicate an increase in energy prices of just over 2% in both 2021 and 2022. With energy weighted at somewhat more than 10% of the HICP, in purely arithmetical terms, headline inflation should rise by around one-quarter percentage point in each of those years.

In this scenario, the mark-up on consumer prices has a dampening effect on households’ purchasing power and thus weakens private consumption, according to the Bundesbank. In addition, higher domestic prices lead to an increase in wages, thus reducing the international competitiveness of the German economy. “As a result, exports remain below their starting level in the scenario without price mark-ups,” the forecast continues. The experts estimate that the level of GDP up until 2022 will fall one and a half tenths of a percent below the baseline level in a scenario without the additional CO₂ price mark-ups.

However, further projects for promoting climate action contained in the Climate Package could broadly offset the dampening effect on growth caused by higher energy prices during the projection horizon up to 2022. With regard to the use of revenues from CO₂ mark-ups, the Bundesbank’s experts envisage that households will profit from transfer payments whilst enterprises benefit from investment incentives, and that government consumption expenditure will increase. Taken as a whole, these measures will boost aggregate demand, thereby also supporting GDP growth.

Projection December 2019