Analysis: German economy to pick up but fall short of traditional pace

BERLIN (Reuters) – Germany’s economy will recover from a bout of winter weakness but fall well short of the dynamic growth rates of previous years as euro zone recession and global slowdown stunt exports and investment.

There are homegrown problems too. What hue of government will result from September elections is injecting uncertainty and foreign investors cite worries about over-regulation and Germany’s future energy mix after Chancellor Angela Merkel turned her back on nuclear power.

Europe’s paymaster was long resilient to the euro debt crisis but contracted at the end of last year and only eked out meager growth in the first quarter.

The Bundesbank said this week a solid second quarter recovery was in prospect. Construction is expected to bounce back after a harsh winter and private consumption will grow thanks to low unemployment, inflation-busting wage increases and low interest rates.

But even the government forecasts just 0.5 percent growth in 2013 and economists doubt German companies will start investing heavily in the short term.

“Nobody expects strong growth for this year now especially as the first quarter was so sobering,” said Christoph Schmidt, head of the German Council of Economic Experts, advisors to the government known as the “wise men”.

The economy grew just 0.1 percent in the first quarter after shrinking 0.7 percent in the last three months of 2012.

“Trade will not contribute much, it could even drag on growth, so that leaves domestic demand,” Schmidt said. “Private consumption is relatively stable but investments are restrained and the key question will be when and how much they pick up.”

Economy Minister Philipp Roesler gave an upbeat spin, telling Reuters “the positive development of the economy will continue” and investment would revive.

And after the Munich-based Ifo think tank’s business climate index climbed on Friday, it said growth should jump in the second quarter thanks in part to a major construction rebound.

But that will be an ephemeral effect. Germany’s DIHK Chambers of Commerce cut its growth forecast for this year to 0.3 percent from 0.7, citing concerns that exports will pick up less strongly than expected.

INVESTMENT POSTPONED

Uncertainty kills investment plans and a survey compiled by the “wise men” shows it is still significantly higher than in the 20 years leading up to the financial and debt crises.

Capital investment is also dependent on world markets since so much of German industry is geared towards exports.

For example, Lanxess (LXSG.DE ), the world’s largest synthetic rubber maker, has reined in its investment budget for 2013 due to weak European car tire markets.

“Without its exports, the German economy is … like a sports car without sixth gear,” said Carsten Brzeski, economist at ING.

Demand for German goods in fast-growing emerging markets such as China has compensated somewhat for Europe, mired in a debt crisis for more than three years. But a global slowdown and a weak Japanese yen have dimmed even that beacon of hope.

Exports to countries outside the European Union dropped 0.2 percent on the year in the first quarter. Sales to the euro zone were down 3.9 percent on the year. Japanese exports, meanwhile, have risen strongly since a new government there demanded expansionary money printing.

“The yen has depreciated by 24 percent since September and in same period there was no change in the euro, so that is a huge advantage, and Japan and Germany are very strong in similar sectors,” said Christian Schulz, an economist at Berenberg Bank.

Kai Carstensen, a senior Ifo economist, expects investment to pick up slightly in the second quarter given the resolution of the Cyprus bank crisis and the appointment of a government in Italy.

But investment would only rise sharply when firms felt more confident, said government advisor Schmidt, and this would only come with a comprehensive solution to the euro crisis.

HOMEGROWN PROBLEMS

In the medium-term, the lack of a government roadmap for dealing with rising energy prices following Chancellor Angela Merkel’s decision to switch to green energy from nuclear is also weighing on investment.

U.S. companies polled by the American Chambers of Commerce in Germany have warned that rising energy prices were making them cautious about investing. They also criticized bureaucracy and over-regulation, with 85 percent saying Germany needed to reform to keep up with its global competition.

Germany only just liberalized the bus sector after decades of protecting the interest of national rail operator Deutsche Bahn DBN.UL by preventing long-distance bus services.

Another cause of uncertainty is the opposition centre-left’s “soak-the-rich” election campaign promises of new taxes even though Merkel, who governs with the pro-business Free Democrats, is still expected to be Chancellor after September’s polls.

Lars Feld, another economic advisor to the government, said Germany should not sacrifice competitiveness just as its European neighbors were reforming to increase theirs.

“The discussion about such enormous tax increases in Germany is already putting a brake on investment,” he said.

Economists warn against too much pessimism over an economy, which is still reaping the benefit of structural reforms it undertook from 2003 to 2005, with which the rest of the euro zone is only now starting to catch up.

Gross domestic product is 1.3 percent higher than pre-crisis levels, according to Tim Moore at Markit research group, an achievement euro zone peers and Britain can only dream of.

Private consumption, which was the only factor driving growth in the first quarter, is the main bright spot – good news for its European neighbors as it suggests Germany will import more.

German consumers were more upbeat going into June than at any point since September 2007 and unions have negotiated rises of on average 3 percent this year, well above inflation which stands at 1.2 percent.

Metro (MEOG.DE ), which runs supermarkets, electricals stores and department stores said Germany was its highlight in the first three months of the year.

Nonetheless, there are limits on how much domestic demand can drive growth unless the economy is rebalanced away from export reliance.

“Germany still needs to do more in order to dynamise its domestic economy,” said the OECD’s Andreas Woergoetter. “It can do more in de-regulating its service sectors.

“If this happens, over the long term we can assume not only the export sector will be attractive for investments but so will the domestic economy,” he said. “This in turn will help growth and … make a further contribution to rebalancing in the euro area.”

(Additional reporting by Victoria Bryan, Peter Dinkloh and Ludwig Burger in Frankfurt, editing by Mike Peacock)