Other downside risks to the economy amid tougher sanctions on Russia

Scope Ratings has further lowered its forecast for economic growth in Germany to between 2% and 2.5% this year and 3% in 2023 (see Table 1), which expected 4.4% growth this year ahead of Russia’s full-scale invasion of Ukraine in late February. This will continue to strain businesses and hamper Germany’s recovery from the pandemic crisis, with economic output now expected to return to pre-pandemic levels in the second half of this year.

We see other downside economic risks, particularly in the event of an EU gas embargo and oil imports from Russia and a long war in Ukraine without any resolution this year. Leading economic research institutes estimate that an immediate embargo on Russian oil and gas would significantly slow growth in 2022 and trigger a deep recession in 2023, with the economy contracting by at least 2%.

To underscore the uncertainty affecting the outlook for Europe’s largest economy, we have summarized the latest baseline growth projections for Germany, covering various scenarios regarding the progression of the war in Ukraine and future sanctions, embargoes on energy and commodity prices.

Table 1: Real GDP growth forecasts for Germany

* Measured in loss of production, which would peak after 1.5 years at 3% of GDP. Source: Respective institutes, Scope Ratings.

The new invasion of Ukraine by Russia has increased inflationary pressure

Russia’s continued invasion of Ukraine added to already strong inflationary pressures, driven by a sharp rise in energy prices. These price increases increasingly translated into wider inflation for other goods and services in Germany, see Chart 1.

Figure 1. Consumer price index and oil prices in Germany

Note: The shaded area represents forecast values ​​from the German Council of Economic Experts. Source: Macrobond, German Council of Economic Experts, Scope Ratings.

The responsiveness of the German consumer price index to energy prices was also higher than in previous periods. This reflects a development recognized by the Bank for International Settlements, in which inflationary pressures affecting one sector are increasingly having ripple effects on other sectors, notably in Germany’s export-oriented economy exposed to long and complex international supply chains.

The rapid rise in inflation is putting pressure on real incomes and household spending. To some extent, increased household savings during the pandemic and well-filled order books will help cushion this impact. However, high-frequency indicators on household consumption, such as the GfK consumer confidence index, are already pointing to a significant contraction in household spending in Germany in response to rising prices.

Private consumption will be one of the main vectors of lower economic growth

In 2022, private consumption will be one of the main drivers of lower growth in Germany, alongside any continued supply chain disruption affecting industry. Nevertheless, any negative effect of rising commodity prices on private consumption will be partially cushioned by the German federal government’s plans for €30-35 billion (about 1% of GDP) in spending to ease cost pressures. of life. Like Germany is moving away from its “black zero” fiscal policyall the measures will appear in the next budget revision scheduled for 27 April.

To assess the effects of higher energy prices on real consumer spending, we use the differential between headline output inflation and private consumption inflation (GDP deflator – private consumption deflator). This indicator aims to capture the compression of real household disposable income triggered by increases in consumer prices above those of aggregate national output. Higher energy prices also lead to price increases of other final goods due to higher prices of intermediate goods.

As Germany imports almost all of its oil and gas, any increase in the price of energy imports leads to a deterioration in the country’s terms of trade (i.e. export prices relative to import prices) and therefore in its wealth and production . The economy therefore does not benefit from the rise in the price of fossil fuels, because the rents from these are exported abroad.

Over the past decade, the gap has been positive in almost every quarter since 2012, with private consumption price increases averaging 1.3%, or 0.3 percentage point below a average of 1.6% for the headline inflation of the GDP deflator. As global oil prices retreated and a low inflation regime took hold, German households enjoyed positive contributions to their real disposable income. The negative differential in 2022 of 1.3% on average reflects the strong pressure on private consumption this year (cf. Chart 2).

Figure 2. GDP and private consumption deflators in Germany

% change, year over year

Note: *The differential is calculated as the percentage change in the GDP deflator over one year minus the percentage change in the private consumption deflator over one year. The shaded area shows forecast values ​​from the German Council of Economic Experts. Source: Macrobond, German Council of Economic Experts, Scope Ratings.

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Eiko Sievert is Head of Sovereign and Public Sector Ratings at Scope Ratings GmbH. Julien ZimmermanSovereign and public sector rating analyst at Scope Ratings, contributed to this commentary.