Significant Cooling of the Economy – Political Risks High: Joint Economic Forecast Spring 2019

The German economy has cooled noticeably since mid-2018, and the long-term upswing has thus apparently come to an end. This weaker momentum was triggered both by the international environment and by industry-specific events. The global economic environment has deteriorated – due in part to political risks – and the manufacturing sector is struggling with obstacles to production. Germany’s economy is currently going through a cooling-off phase in which capacity shortages in the economy as a whole are declining. The institutes expect economic growth of only 0.8% in 2019, which is more than one percentage point less than in autumn 2018. However, so far they consider the chance of a pronounced recession with negative rates of change to gross domestic product (GDP) over several quarters to be slight – at least as long as the political risks do not intensify further. For the year 2020, the institutes confirm their forecast from last autumn: gross domestic product is expected to increase by 1.8%.

04. April 2019

Authors Projektgruppe Gemeinschaftsdiagnose

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Global economy
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German economy
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The economic situation varies considerably from region to region: in the US, the upswing merely slowed down, whereas in the euro area, it came to a standstill in the second half of 2018, mainly due to the pronounced weakness of German and Italian industry. Signs of an economic slowdown in China came in the early part of last year, but only the country’s very weak imports in the final quarter of 2018 suggest a downturn there.

To some extent, the cooling of the global economy in the course of 2018 is better understood as a normalisation after the exceptionally strong upswing in 2017. However, it is also a consequence of major economic policy risks. It is still not clear how the trade conflict pitting the US against China and the European Union (EU) will play out. The second uncertainty in Europe is the UK’s withdrawal from the EU. It is unclear whether this will be regulated by an agreement or unregulated, or if and for how long it will be postponed.

The international economy also faced a headwind in the form of US monetary policy. In 2018, the US Federal Reserve raised its key interest rate by a total of one percentage point to a range of 2.25–2.5%, and as a result financing conditions in many emerging markets deteriorated significantly at times. Other dampening one-off effects in the third quarter of 2018 included natural disasters in Japan and weak vehicle sales in many places, partly due to difficulties in converting to a new exhaust gas testing system in the EU and elsewhere.

It is not only in the automotive sector, but also in manufacturing in general that the economy has cooled off sharply. This may be partly because duties or risks of tariff increases usually affect trade in goods, but not in services. At any rate, the mood in manufacturing companies in almost all countries has deteriorated much more dramatically than among service providers, and world industrial production has lost considerably more momentum than the economy as a whole. Not least because the service sector remains intact, employment in most advanced economies has expanded until recently, albeit at a slower pace, and wage growth has tended to accelerate, with unemployment often very low. However, except for oil-price-related fluctuations, consumer price inflation remains generally low (as in the euro area and in particular Japan) or moderate (as in the US).

Against this backdrop, monetary policy in many places has reacted to the economic slowdown and suspended or loosened the tightening course previously adopted. The US Federal Reserve announced its change of course in January 2019, the European Central Bank (ECB) in March. However, as early as the end of 2018, players in financial markets were no longer expecting near-term hikes in key interest rates in the US, and capital market yields have tended to decline since then. A return to more favourable financing conditions is of particular benefit to emerging markets, which are dependent on inflows of foreign capital.

Fiscal policy varies from region to region. In the US, it is less expansionary, with the stimuli from the tax reform adopted at the end of 2017 and from spending programmes expiring in the forecast period. An increase in Japanese VAT in the autumn of 2019 will have a restrictive effect. In contrast, fiscal policy in the euro area will change this year from being more or less neutral to being slightly expansionary, mainly due to measures taken in Germany and Italy. Finally, the Chinese government has decided to introduce substantial tax cuts for consumers and companies in order to stabilise its economy.

Economic policy will therefore generate opposing stimuli in the forecast period: on the one hand, monetary and fiscal policy will support the international economic situation; on the other, high levels of uncertainty about the progress of the trade disputes and the UK’s withdrawal from the EU continue to weigh on the global economy. Leading indicators, for example, do not paint a clear picture of the international economy in the first half of 2019: the mood in industry has fallen until recently, as have incoming orders. In addition, US production in the first quarter is likely to have been significantly dampened by the government shutdown in January and the severe cold in February. However, other indicators also point to the possibility that the economic cycle has bottomed out: share prices and prices for many industrial commodities rose again at the beginning of the year, and risk premiums – measured by the yield spread between otherwise comparable bonds issued by issuers with different levels of risk – fell. In addition, consumer confidence in advanced economies in general remains high. The upswing in the US will probably continue for some time despite temporary dampening effects and the economic policy measures in China are likely to gradually take effect. Taken together, these facts also point to a somewhat stronger expansion of production in the further course of this year. Furthermore, it is to be expected that the economies of some emerging countries will pick up again in the current year after slowing significantly in 2018.

In 2020, US and euro area production will expand close to their potential, while the trend towards somewhat lower growth in China will continue. All in all, it is to be expected that overall economic production in the countries considered here will increase at a rate of 2.7% (weighted by exchange rate) in 2019 and 2020, which is significantly slower than in 2018. Compared with the Joint Economic Forecast for autumn 2018, this represents a downward revision of 0.3 and 0.2 percentage points, respectively. The slowdown is even more pronounced from a German perspective (world production weighted by the shares of German exports). World trade in 2019 is likely to be only 1.6% higher than in 2018, but will pick up noticeably over the course of the year.

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