db research

8/3/2019 DB Research

1/12

Germany

Curre

ntIssues

Authors

Bernhard Grf+49 69 [email protected]

Tobias Just+49 69 [email protected]

Jochen Mbert+49 69 [email protected]

Stefan Schneider+49 69 [email protected]

Editor

Stefan Schneider

Technical Assistant

Manuela Peter

Deutsche Bank ResearchFrankfurt am MainGermanyInternet: www.dbresearch.com

E-mail: [email protected]: +49 69 910-31877

Managing Director

Thomas Mayer

The German economy weathered the crisis commendably. The pace

and vigour of the V-shaped recovery surprised economic forecasters. With growth

of 3.6% the best performance since its reunification Germany was the star

performer on the growth stage in the euro area.

Super year 2010 saw the German economy benefit from four factors

in particular: the inventory cycle, the catch-up effects from investment activitypostponed in 2009, the recovery of the global economy accompanied by a revival

of world trade, and expansionary monetary and fiscal policies.

However, these factors are petering out (inventory cycle and catch-up

effects for investments), losing momentum (global economy) or even

acting as a constraint (fiscal policy). For this reason, German GDP growth

is expected to continue reverting to normal in 2011. Nevertheless, it remains

robust and at a prospective expansion rate of 2% should again far outstrip its

potential. This would more than offset the deep slump in 2009.

Developments in the labour market remain very encouraging. On

average, 2011 will probably see the number of unemployed fall below the 3 million

mark, with the unemployment rate easing from 7.7% towards 7%.

Stable core inflation. At the end of 2010 the inflation rate was 1.7% mainly

because of higher prices for heating oil and fuels. A sustained acceleration of core

inflation is not to be expected despite GDP growth that is still far outstripping its

potential, since the economys capacities are still being under-utilised and wage

growth remains moderate. Nor are inflationary effects visible to date from either

monetary or fiscal policy. For this reason we expect average annual inflation to

come to roughly 2% in 2011, after 1.1% in 2010.

On the issue of public finance, Maastricht is in sight. The burgeoning

recovery, the upswing in the labour market and the measures of the austerity

package should provide relief for public budgets. This is why we think the general

government deficit could realistically shrink to about 2 % of GDP in 2011,

bringing Germany back into line with the budget criterion of the Stability and

Growth Pact already in the course of this year.

February 14, 2011

Outlook 2011:

German growth remainsrobust


2/12

Current Issues

2 February 14, 2011

Outlook 2011:

German growth remains robust

Super year 2010

The growth momentum shown by the German economy in 2010

surprised economic forecasters. No-one had expected to see aV-shaped recovery materialise at such a fast pace or with suchvigour. With growth of 3.6% the best performance since itsreunification Germany was the star performer on the growth stagein the euro area, outstripping the US economy by roughly per-centage points. The foundation of this performance was mainly laidin Q2 2010 when real gross domestic product increased by 2.3% onthe previous quarter. Under US accounting rules, i.e. wherequarterly growth is extrapolated for the full year, the economyexpanded by a whopping 9.4% in the second quarter!

Super growth year 2010 saw the German economy benefit from

four factors in particular:

1. The inventory cycle, both international and national. During the2009 recession production was cut back sharply and inventorieswere slashed. These were slowly rebuilt in the course of 2010.

2. The catch-up effects from investment activity postponed in2009. In a sign of the deep uncertainty that paralysed the globaleconomy after the bankruptcy of Lehman Brothers, investmentswere cancelled or temporarily shelved. In Germany, investmentin machinery and equipment plunged nearly 23% in 2009. Thisinvestment backlog eased last year around the globe. The

boom in Germany was additionally spurred by infrastructureinvestment in connection with government stimulus packages.

3. The recovery of the global economy accompanied by arevival of world trade, which particularly stimulated the Germaneconomy thanks to its heavy export bias. Over the past year theglobal economy grew by roughly 4 % on the heels of negativegrowth of close to 1% in 2009, the first decline in the postwarperiod. The IMF estimates that world trade expanded by 11 %in 2010 following a downturn of a similar magnitude in 2009.

4. The expansionary monetary and fiscal policies in Germanyand worldwide. The programmes launched in the OECDcountries to fight the recession had a volume of around 2 % ofGDP in 2009 and 2010.

These factors are reflected in the growth mix of the German

economy. Last year, inventory-building and investment in equipmentgenerated 22% and 28% of GDP growth of 3.6%, respectively, witha further 30% coming from net exports.

Germany is the worlds outfitter

The rebound in the investment cycle, particularly in the emergingmarkets of Asia, benefited Germanys exporting industry given itsrole as the worlds outfitter. Germany has exactly the right country

and product mix in its export portfolio. This is impressivelydocumented by the scale of Germanys exports to China, nearly

70% of which constitute machinery and transport equipment, i.e.capital goods, and which expanded by 45% last year, whileGermanys total exports increased by merely close to 20%. With

capital goods accounting for over 45% of its total exports, Germanyis the leading such exporter in Europe. Moreover, the importance ofthe dynamically growing emerging economies of Asia and of China

-8

-6

-4

-2

0

2

4

6

-4

-3

-2

-1

0

1

2

3

07 08 09 10

% qoq (left) % yoy (right)

GDP growth% qoq (left), % yoy (right)

Sources: Federal Statistical Office, DB Research 1

-6

-4

-2

0

2

4

2008 2009 2010

Net exports

Inventories

Investment

Government consumption

Private consumption

Real GDP (% yoy)

Contributions to growthpp


-40

-20

0

20

40

60

80

07 08 09 10

Total exports China

German exports% yoy

Source: Federal Statistical Office 3


3/12

Outlook 2011

February 14, 2011 3

in particular has noticeably increased over the past few years.In 2010 alone, the export share to China rose by one percentagepoint to over 5 % of Germany's total exports, putting them nearlyat a par with exports to the United States, which accounts for about6 % of German exports. All in all, more than 11% of Germanexports are shipped to the emerging markets and developing

countries of Asia.

Special effects of super year 2010 petering out

Three of the four factors discussed here that drove growth in thesuper year 2010 are petering out, these being the economic policystimuli, the inventory cycle and the investment catch-up effects.The fiscal packages to stimulate the economy have been phasedout and many countries have already initiated consolidation pro-grammes, marking the turning point in their fiscal policy. In Germany,this was done by means of the austerity package adopted last year.

In many quarters, inventories have been assessed of late as havingreturned to reasonable levels, so it is unlikely that companies will

continue to build them up, at least on a larger scale. This suggeststhat there will not be any significant growth stimuli in the current yearfrom changes in inventories.

In addition, the momentum of world trade started to weaken in thesecond half of 2010, and purchasing managers assessments ofexport orders have already been trending down worldwide sinceroughly mid-2010. This might be an indication that the investmentactivity postponed in 2009 has now been completed and thatdemand from abroad may have returned to normal accordingly.

Global growth losing momentum

It could also indicate, though, that the underlying business cycle in

key regions of the world may generally have weakened a tad. Whilewe are relatively optimistic on the prospects for the US economy,this undoubtedly does apply to Japan. The Japanese economy islikely to show more or less flat growth in 2011. But in the emergingmarkets of Asia, too, where growth is already moderating in China inparticular as politically desired weaker dynamics are on thecards. Following a 10% increase in 2010 we look for real GDP togrow by 8 % in China in 2011. Thus, the expansion of the globaleconomy is set to slow in 2011 to 4%, after 4 % in 2010. But thiswould still match the average growth of the past ten years.

Eurozone remains a laggard in the economic cycle

Not only Asias emerging economies are expected to place fewer

orders with German businesses, though. Considering the adjust-ments necessary in the European crisis countries, i.e. mainlyGreece, Ireland, Portugal and Spain, these are also likely to be aweaker source of stimuli for German exports. The consolidationefforts in the public sector in particular, but also in the private sector,will noticeably curb these countries growth and thus their imports.

We expect Greece to remain mired in recession in 2011, whilePortugal relapses into recession and Spain at best stagnates.However, this will not necessarily cause German exports to slump,since bilateral trade relations between Germany and these countriesare very limited. Combined, exports to Spain, Ireland, Portugal and

Greece only account for a good 5% of total German exports. By

contrast, in other eurozone countries that are more important forGermanys exporting industry, e.g. France (over 10% of exports in

2009), the Netherlands (6 %), Austria (6%) and Belgium (5 %),

0

2

4

6

8

10

12

91 93 95 97 99 01 03 05 07 09

China

Southeast Asian EMs

Other Asian countries

German exports to Asia% of total exports


Global growth

% yoy

2009 2010F 2011F

US -2.6 2.9 3.8

Japan -5.2 4.2 0.8

Euro area -4.1 1.7 1.2

UK -4.9 1.4 1.8

Asia 5.7 9.4 7.6

China 8.7 10.0 8.7

India 5.8 9.8 8.2

Latin America -2.4 6.0 4.3

Brazil -0.2 7.7 4.5

EMEA -5.2 4.5 4.5

Russia -7.9 4.0 5.0

G7 -3.5 2.8 2.5

World -0.8 4.8 4.0

Sources: IMF. DB Research 5

Euro area: GDP growthReal GDP (% yoy)

2008 2009 2010F 2011F

Euro area 0.3 -4.1 1.7 1.2

Germany 0.7 -4.7 3.6 2.0

France 0.1 -2.5 1.5 1.2

Italy -1.3 -5.1 1.1 0.9

Spain 0.9 -3.7 -0.3 0.2

Netherlands 1.9 -3.9 1.6 1.2

Belgium 0.8 -2.7 2.1 1.6

Austria 1.9 -3.7 1.8 1.6

Finland 1.0 -8.1 2.8 2.5

Greece 2.0 -2.0 -4.2 -3.5

Portugal 0.0 -2.6 1.6 -0.5

Ireland -3.7 -7.6 -0.5 0.5

Sources: National statistical offices,Central Banks, DB Research 6


4/12

Current Issues

4 February 14, 2011

the economic recovery is continuing with only slightly weakenedmomentum but budget consolidation is underway there too.

As a whole, the eurozone is expected to see growth of close to1 % in 2011, after 1 % in 2010, with performance still beingdriven primarily by the German economy. Excluding Germany,

eurozone growth would be merely on the high side of % in 2011 as in 2010. This means that the growth picture in the eurozone hasreversed. While the southern peripheral countries driven byexcessively low real interest rates and booming real estate markets posted robust growth over the past decade and left Germanytrailing in the dust, the reverse scenario is likely to materialise in thecoming years if the necessary consolidation of public and private-sector budgets on the periphery leads to feeble expansion.

Export engine losing power

Purchasing managers less enthusiastic assessment in H2 2010 of

future global export orders (although slightly up recently) suggeststhat German export growth dynamic probably peaked last autumn

and that exports will grow this year at only about half the pace of2010, or roughly 7 % in real terms. Thus German shipmentsabroad will increase at roughly the same pace as global trade, andthe nearly synchronous pattern of global trade and German exportson record for many years is set to continue, which considering theincreasing world market shares of the emerging economiesimpressively underscores the competitiveness of German industry.

External contribution to remain unchanged at around onepercentage point

Since demand for imports is also set to ease during the stage ofslower economic growth following an increase of 13% in 2010 we

expect to see real imports climb by only 6 % or so in 2011 netexports are likely to repeat their contribution of roughly one per-centage point of economic growth in the current year. In nominalterms Germanys trade surplus will equal about 6% of GDP in 2010,

with the current account surplus coming in at about 4 %.

Cloud over investment activity

Given the pronounced export bias in the German economy, weakerexport growth is also going to cast a cloud over investment activity.Goods exports generate about 33% of GDP, and the inclusion ofservices ups the percentage to no less than 40%. However,Germany also imports goods and services worth around 36% ofGDP.

Investment in machinery and equipment recovered in 2010 from adramatic slump in 2009 (-22.6%), increasing by close to 10%. Thiswas probably partly driven by purchases being brought forward, asthe option of using declining-balance depreciation on moveableassets expired at the end of 2010. Nevertheless, at end-2010investment in machinery and equipment still fell more than 10%short of the pre-crisis level. With capacity utilisation rising slowly, thegrowth to date probably came largely on the back of replacementinvestment and not so much investment in expansion.

Given weaker external stimuli and the disappearance of brought-forward purchases we look for more moderate investment growththis year. This is underpinned by the fact that in early 2011 capacityutilisation is still slightly below average. Besides, the reading is still 5percentage points lower than the average in 2006 and 2007 wheninvestment in machinery and equipment increased by over 10%

-25-20-15-10-505101520

00 01 02 03 04 05 06 07 08 09 10 11

Investment in machinery & equipment

Real exports

Exports & investments

% yoy


75

80

85

90

95

100

105

110

07 08 09 10

TotalMach. & equipmentConstruction

Q1 2007=100Investment


30

35

40

4550

55

60

-30

-20

-10

010

20

30

03 04 05 06 07 08 09 10 11

German exports (left)Global export orders* (right)

Global export orders andGerman exports% yoy (left), % (right)

*brought forward by 4 months

Sources: J.P. Morgan, NTC Research,Federal Statistical Office

7


5/12

Outlook 2011

February 14, 2011 5

each year. All in all, investment in machinery and equipment is onlyexpected to pick up by about 5 % in 2011, after 9.4% last year. Wethink there is little probability of a pronounced weakening of invest-ment activity considering the still favourable outlook for corporateearnings, the extremely low interest rates and the general con-fidence of German industry. In November 2010, the Ifo Business

Climate Index for German industry and trade climbed above its lastpeak, which had been reached during the 2006/07 boom, andcontinued to rise in December. Companies were very optimistic intheir assessments of both the current business situation andprospects for the next six months. And at close to 61 points thePurchasing Managers Index clearly outstripped the 50-point markdelineating the border between growth and recession.

Construction impacted only minimally by the crisis

Unlike manufacturing, Germanys construction industry had been

affected only minimally by the economic crisis. One reason is thatconstruction did not experience a veritable boom as in many other

European countries. In fact, before the crisis hit, construction hadbeen well on its way towards recovering from the ten-year structuraladjustment that had eroded one-third of German constructionactivity since the mid-1990s. Another reason is that the public sectorhad invested extensively in civil engineering projects and inmeasures to enhance the energy efficiency of privately and publiclyowned buildings in order to prop up the sector. This resulted in theorder volumes (of the construction industry) remaining roughly atpre-year levels in both the civil engineering and the residentialsegments even in the depths of the 2009 recession. Only the heavilycyclical commercial building segment was rocked to its foundationsby a double-digit percentage slump in incoming orders. The pictureis set to change in the course of this year: while civil engineering islosing ground because of the expiry of public stimulus measures,commercial building is starting to gain territory from a very low basisthanks to the pick-up in economic activity; the volume of civilengineering is likely to contract by about 5% in 2011, whilecommercial building will probably expand by a roughly similaramount. However, because small firms are not included when theconstruction output statistics are gathered and because these firmsbenefit more than others from renovation projects, the figurereported in the national accounts is likely to show a smaller increasein commercial building investment. What is noticeable in any eventis the strong jump in residential construction: the number of buildingpermits was up by close to 7% on the year-earlier figure during the

first ten months of 2010, while the number of permits for multi-familydwellings was up by close to 10% yoy no less. Also the number ofnew orders for residential construction outstripped the pre-yearreading up to October 2010 by around 10%. For 2011 the recoveryin residential building should more than compensate for the adjust-ment strains in the civil engineering segment. We expect theconstruction industry as a whole to see an increase in full-yearoutput.

Industry benefiting strongly from global recovery

Manufacturing output slumped by over 17% in 2009, affecting thecapital goods segments in particular: mechanical engineering and

metals production both saw output drop by over 25%. In Q2 2009,capacity utilisation in the manufacturing sector declined by morethan 15 percentage points to slightly over 70%, reaching the lowestlevel since at least 1960 earlier data is not available. Only the food

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100

120

140

160

00 01 02 03 04 05 06 07 08 09 10

Civil engineeringOther structural

Residential construction

Residential constructionis recoveringIncoming orders, 2000=100, sa, smoothed

Source: Destatis 11

30

35

40

45

50

55

60

65

80

85

90

95

100

105

110

115

00 02 04 06 08 10

Ifo Index (left)

Purchasing Managers Index (right)

Confidence indicators2000 = 100 (left), % (right)

Sources: ifo, Reuters 10

Industrial production% yoy

Sectors 2008 2009 2010F 2011F

Food 0.2 -0.5 1.5 1.5

Drinks -1.7 -4.0 1.5 1.5

Textiles -4.5 -19.6 12 0

Clothing -14.6 -14.0 0 -5

Chemicals -3.8 -14.3 18.5 3.5

Pharma 3.3 -2.2 1.5 1.5

Plastics -1.9 -10.5 13 5

Metal prod. -1.1 -27.2 22 3Met.products 2.0 -21.8 14.5 5

Electrical

engineering 5.1 -20.4 12.5 6

Mechanical

engineering 5.0 -26.0 9 11

Auto -3.8 -21.7 24 12.5

Manu-

facturing 1.0 -17.3 11.5 6.5



6/12

Current Issues

6 February 14, 2011

and pharmaceuticals industries largely avoided falling into recession at least in terms of their production volume growth thanks totheir low susceptibility to fluctuations.

However, in the subsequent quarters government monetary andfiscal stimulus programmes helped to kick-start a huge global

increase in demand. German industry was among the beneficiaries:in fact, up to December 2010 the manufacturing sector reportedforeign orders up more than 50% versus their low, while domesticorders were up roughly 30%. This recovery benefited the capitalgoods industries in particular. The early-cycle sectors (chemicalsand metals production) as well as the automotive industry, boostedby the scrappage bonus, regained their footing fastest. However,growth in these sectors already started to cool noticeably in thesecond half of 2010 at the latest reading, metals production andmetals processing did not even register a further increase in theirorder volumes. The late-cycle sectors such as mechanicalengineering and (with a few slight exceptions) the auto industryare not yet feeling the brakes on their momentum. They are not

expected to see growth start weakening until later in 2011.

All in all, manufacturing output grew by 11.5% in 2010; for 2011,however, we expect production growth to slow to only about 6.5%close to half of this will be attributable to a statistical overhang i.e.the expansion in 2010. So the crisis-induced demand slump couldbe nearly overcome by late 2011. While the upswing in electricalengineering and mechanical engineering is continuing virtuallyunbridled, we expect both metals production and the chemicalsindustry to see their growth rates ease considerably.

Encouraging labour trend continues

Unlike all the other industrial countries, Germanys labour market

weathered the crisis extraordinarily well. Thanks to the extension ofshort-time work schemes, companies good financial situation andthe flexible working hours negotiated in collective wage agreements(including working-time accounts), unemployment increased onlyslightly during the 2009 crisis. This demonstrates how targetedreforms have boosted the flexibility of the German labour market.Over the past year the number of unemployed fell by roughly260,000 to slightly over 3 million people at last reading (seasonallyadjusted). This was its lowest level since 1992. The unemploymentrate fell accordingly from its last high of 8.3% in summer 2009 to7.4% recently. Moreover, during the recovery the number of hoursworked was boosted strongly, and the number of people on short

shifts was reduced from around 1 million to about 200,000. Thelow number of new registrations suggests that the number of short-time workers will trend down further in the coming months. Besides,the number of workers obliged to make social-security contributionsincreased by nearly 1% in 2010, after decreasing by 0.2% in 2009.

Exports, investment activity and probably also employmenttrend all returning to normal

While the uptrend in job vacancies and the currently large number ofcompanies planning to hire new staff point to a still faster increase inemployment, this strikes us as being overly optimistic given theheavy dependence of employment on exports. Our expectations of

weakening export and investment growth suggest that total employ-

ment is likely to grow in the current year at roughly the same paceas in 2010.

50 60 70 80 90 100

Auto

Chemicals

ElectricalengineeringMechanicalengineering

Metals processing

Manufacturing

2009 lowRecovery since 2009 low up to nowRemaining gap to 2008 peak

Utilisation higher againCapacity utilisation in Germany (%)


90

95

100

105

110

115

120

07 08 09 10 11

Slowing upswing

+6.2% +1.0%

-17.3%

+11.5%

+6.5%

Production index, manufacturing, seasonallyadjusted, smoothed, 2005=100


5

6

7

8

9

10

11

12

13

2

3

4

5

6

05 06 07 08 09 10 11

Number ofunemployed(left)

Unemployment rate(right)

Seasonally adjusted, million (left), % (right)

Sources: Federal Labour Agency, DB Research

Unemployment

15

0.00.20.40.60.81.01.21.41.6

07 08 09 10 11Total New registrations

Short-time workerMillion

Source: Federal Labour Agency 16


7/12

Outlook 2011

February 14, 2011 7

Unemployment is set to trend down further and the number ofunemployed should sink to just under 3 million on an annualaverage, bringing the unemployment rate down towards 7%accordingly.This means that Germanys labour market performancewill remain a good example for others not only in Europe.

Private consumption gaining momentumGiven the continuing recovery of the labour market and the improve-ment in consumer confidence, the hopes of private consumptionregistering a sustainable recovery have also risen of late. Eventhough retail sales had only picked up by a good 1% in real terms in2010, retailers have become significantly more optimistic.

But will private consumption evolve from a source of hope into adriver of growth? Probably only to a limited extent. Since it hasproved a disappointment every year since 2000 with an averageincrease of just over % and in fact has more or less stagnated forthe past four years we expect to see an increase of 1 % in realterms in 2011. However, private consumption cannot compensate

for the weaker growth stimuli from net exports and investment.

Despite the top-up debate shaping up over wages and salaries weexpect to see an only moderate increase in 2011. While not quiteone-third of all collective agreements are set to expire in 2011, one-off payments and positive wage drift will support incomes. All in all,total gross payrolls are likely to increase by over 2 % this year, upfrom 2 % in 2010. The transfers received by households are likelyto increase at a slightly slower pace in 2011, while corporate andinvestment income are poised to jump faster than labour remuner-ation. So, all in all we expect disposable income to increase bynearly 2 % in 2011. This is tantamount to a real increase of around1 %, which provides scope for us to forecast an increase in private

consumption on a nearly constant savings ratio.

2011: Robust, sustainable 2% growth

The individual components add up to growth of 2% for the currentyear, while we believe expansion of roughly 1 % is conceivable for2012. On a quarterly basis we expect the growth of the Germaneconomy to return to normal in the course of 2011 with rates of 0.3%to 0.4% per quarter. The increase in real GDP is thus expected tofall noticeably short of the performance in 2010, when the specialfactors discussed above stimulated growth and drove the rate up to3.6%. However, total economic growth is again running noticeablyhigher than its potential, and Germanys is the highest among the

larger eurozone economies. Besides, growth is becomingincreasingly self-sustaining since fiscal policy is now turning morerestrictive in the wake of the stimulus packages as foreseen with theausterity package, and no additional boost is to be expected frommonetary policy.

Is Germany not doing enough for the domestic economy?

Roughly half of the expansion in GDP is being driven by net exportsand half by domestic activity. Back in 2010 the growth mix was stillabout 30% to 70%, with the domestic side tipping the scales.

Internationally, Germany is being accused of doing too little for itsdomestic market, concentrating overly strongly on the competitive-

ness of its exports and generating correspondingly high externalsurpluses which, like the large deficits in the problem countries ofEurope, could be manifestations of sectoral distortions. Robust

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1234

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-100

10

20

30

00 02 04 06 08 10Nominal exports, 3M mov. avg. (left)

Workers obliged to make soc.-sec.contrib. (right)

Exports & employment% yoy


-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.53.0

00 02 04 06 08 10

Real private consumption% yoy


Germany:

Forecasts at a glance% yoy

2009 2010 2011

Real GDP -4.7 3.6 2.0

Private consumption -0.2 0.5 1.3

Gov't expenditure 2.9 2.2 0.8Fixed investment -10.1 5.5 3.1

Investment in M&E -22.6 9.4 5.8

Construction -1.5 2.8 0.7

Exports -14.3 14.2 7.4

Imports -9.4 13.0 6.6

Consumer prices 0.2 1.1 2.0Budget balance,% GDP -3.0 -3.5 -2.8Unemployment rate,% 8.2 7.7 7.1

Balance current account,

% GDP 5.0 5.0 4.7



8/12

Current Issues

8 February 14, 2011

domestic activity would boost Germanys imports, reduce the tradesurpluses and in turn give growth in the problem countries a fillip.

But is there any substance to this accusation? We dont think so.

True, net exports generated about three-quarters of Germanysaverage GDP growth of 1.2% from 2001 to 2008. However, the

result of such a comparison hinges strongly on the period chosen,as shown by chart 20. From 1995 to 2008 GDP growth averaged1.6% p.a., with the contribution from net exports coming to not quite40%. Moreover, German imports expanded at nearly the same paceas global trade. This documents the strength of the stimulusprovided by Germany for the global economy also partly becauseGerman exports display a large percentage of foreign input in termsof preliminary and intermediate products. Export-induced importsare found in considerably more than 40% of German exports. Thismeans that other countries also benefit from robust increases inGerman deliveries.

Moreover, the stronger growth of the domestic markets in other

European economies over the past few years is largely attributableto an overabundance of credit-driven growth in their real estatemarkets thanks to extremely low real interest rates. By contrast,Germany where interest levels appropriately reflected thebusiness cycle and where there was no property market boomwas referred to as the sick man of Europe. Household debt has

surged in relation to disposable income in many countries since thelaunch of the euro, nearly doubling in some cases (in Italy andSpain, for instance) or even trebling (Greece). The opposite is truein Germany where it has declined. This tends to apply equally interms of corporate debt. It now emerges that events in Germanywere much healthier for the economy than in other countries whosedomestic demand was cited as an example for Germany, but whose

performance did not prove sustainable and compelled the countriesaffected to adopt consolidation packages lasting several years. Amore balanced economic performance with stronger domesticactivity is certainly to be welcomed. The only question, though, is atwhat price.

German growth potential: Lower after the financial crisis?

Debate has intensified again lately on Germanys potential growth

rate. While some believe potential growth will remain lower per-manently, other forecasts project higher growth potential thanks tosuccessful reforms, particularly in the labour market.

GDP can be regarded as a combination of potential output and a

cyclical component. The potential output of an economy refers to thetotal economic output that can be produced making use of theproduction factors labour and capital that are available at a giventime. The calculation takes account of technological progress andassumes normal capacity utilisation. Hence, the cyclical componentequals the fluctuations in the utilisation of the overall potential. Forthe purpose of economic analysis it is important to be aware ofpotential growth, as it defines the maximum pace at which aneconomy can grow over a longer term without leading to tensions inthe labour market and an acceleration of inflation. Once potentialgrowth has been determined, other important indicators used in theanalysis of the business cycle and inflationary risks, such as the

output gap (i.e. the gap between potential and actual GDP) andstructural unemployment, can also be calculated.

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-1

01

2

3

4

92 94 96 98 00 02 04 06 08 10

Domestic market

External contribution

Real GDP (% yoy)

Contributions to growthpp


-15

-10

-5

0

5

10

15

20

95 97 99 01 03 05 07 09

German imports

World trade

World trade & Germanimports

% yoy

Sources: IMF, Federal Statistical Office 21

0

20

40

60

80

100

120

GR ES IT PT DE

1999

2008

Household debt% of GDP

Source: Eurostat 22

Potentialoutput

Actual GDP

Timet

Value

Potentialoutput

Cyclicalcomponent

Potential output &business cycleSchematic

23


9/12

Outlook 2011

February 14, 2011 9

However, growth potential cannot be observed directly, like forinstance the number of persons in gainful employment or prices forindividual goods. Therefore, estimates must be made usingstatistical procedures. Various methods can be used to do this,such as average, trend and filter procedures as well as productiontechnology procedures. The filter procedures, including the

frequently used Hodrick-Prescott filter, are relatively simple in theirapplication, but they have the disadvantage that they actually needa completed economic cycle for analytical purposes. Given this end-point problem they are very unreliable for analyses of the latestdata. Besides, they do not allow any conclusions to be drawn aboutthe reasons for a change in potential output. Production technologyprocedures that explain potential output via the factors involved inthe production process i.e. labour, capital and technologicalprogress (total factor productivity) avoid this disadvantage (theadjacent table shows how Germanys Council of Economic Experts

calculates potential output).

Potential growth roughly 1 % in 2011, ...

There is little disagreement among the major economic researchinstitutes as regards potential growth for 2011. The Council ofEconomic Experts, like the IMF and the OECD, forecast 1 %potential growth for the German economy in the current year. Ourown analysis also arrives at roughly this rate. Hence the currentgrowth rate of potential output is roughly in line with the average ofthe last five years.

... scarcely affected by the crisis, ...

To be sure, the basis for determining potential growth is highlyuncertain at present. Nonetheless, analysis shows that growthpotential has so far not been noticeably affected by the financialcrisis. This may seem surprising at first glance as earlier financialcrises did have an evidently negative impact on the rate of potentialgrowth, which was a result of sectoral distortions and a relatedincrease in structural unemployment. In Germany, though, there wasno real estate boom like in many other countries. Accordingly, unlikein the United States, Britain, Spain or Ireland, for instance, therewas no need for adjustments in the construction industry. Wetherefore do not expect an increase in structural unemployment inGermany, nor

related consequences for Germanys growth potential.

According to OECD estimates, structural unemployment in Germanyis even lower at present than in mid-2000, while the countries whichexperienced serious bubbles in their property markets and con-

siderable sectoral adjustments when these bubbles burst areexpected to be confronted with substantially higher structuralunemployment and as a result lower growth potential.

... but will be squeezed by the demographics over the long term

Even though the financial crisis has not severely harmed Germany'sgrowth potential, demographic shifts mean there are still enormouschallenges ahead. Germany's population will shrink by 20% by2060. At the same time, the labour force aged between 15 and 65years will decline by no less than 35%, as the baby-boom gener-ation will soon start to reach retirement age and be replaced onlypartially by the cohorts born in years with low birth rates. The

shrinking of the working-age population will accelerate considerablyand exceed more than 1% per annum between 2020 and 2035. Allother things being equal, this would imply stagnation in potentialoutput.

Germany: Potential output

Poten-tialoutput

Labourvolume

Capitalstock

Totalfactorproduc-tivity

Growth contribution

% yoy pp

1971-80 2.7 -0.8 0.9 2.6

1981-90 2.3 0.0 0.6 1.8

1991-00 2.1 -0.1 0.6 1.6

2001-06 1.3 -0.1 0.5 1.0

2007 1.2 0.0 0.4 0.8

2008 1.2 0.0 0.4 0.8

2009 1.2 0.1 0.4 0.8

2010 1.3 0.2 0.4 0.8

2011 1.3 0.2 0.4 0.8

2012-16 1.0 -0.2 0.3 0.8

Source: German Council of Economic Experts(2010/11) 24

40

60

80

100

120

140

160

180

200

2000 2002 2004 2006 2008

US DE

ES IE

GB

House prices

Source: OECD

House price in relation to income,long-term average = 100

25

-1.6

-1.4

-1.2

-1.0

-0.8

-0.6

-0.4

-0.2

0.0

2010 2020 2030 2040 2050 2060

Total 15-65 cohort

Source: Federal Statistical Office

Medium variant, lower limit

Population

Population development% yoy

26


10/12

Current Issues

10 February 14, 2011

Decline in growth potential probably inevitable in the long run

A decline in the growth rate of Germany's potential output appearsinevitable. The Council of Economic Experts already expects growthpotential to fall to only 1% per year for the period 2012 through2016. Just how sharply Germanys growth potential will fall over a

longer-term horizon, when the damping effects of demographicchange will be strongest, will depend on how society decides onissues such as the start of the working life, the retirement age,gainful employment, annual working hours as well as immigration.

Monetary policy: ECB in a difficult situation

Given the diverging economic patterns in the core and peripheralEMU countries as well as persistent problems in the banking sectorsof various countries, the ECB finds itself between a rock and a hardplace. Since the situation varies very considerably from country tocountry and thus policy changes also have an asymmetrical impact,it is difficult to gear policy to the eurozone average.

We believe that the ECBs willingness to stage an exit from its

extremely relaxed monetary policy should not be underestimated,and we expect it to start tightening the monetary reins in the secondhalf of 2011 at the latest. True, not too long ago it did decide topostpone the exit from its fixed rate tender procedure with fullallotment. But by saying that up until March the interest rate on 3-month refinancing operations will be set at the average of the one-month refi rates within these periods the ECB has indicated that thisrate may indeed head north. Moreover, it spoke of the separation

principle, i.e. that it could always boost key interest rates before

exiting from its full allotment policy for refinancing operations andreverting to normal auction procedures. The ECB probably madethis reference to avoid undermining the credibility of its monetary

stance. However, such steps will hardly be up for discussion untilsome way is found to defuse the sovereign debt crisis facing theperipheral countries.

Nevertheless, the ECB is still likely to be the first central bankamong the major industrial countries to reverse the thrust of itsmonetary policy. In doing so it will be confronted with far fewerproblems than the Fed, which recently decided to extend itsquantitative easing policy by purchasing long-term US Treasuriesand which could expand its balance sheet by up to a furtherUSD 900 bn, to over USD 3,200 bn, by the end of the secondquarter. By contrast, the ECBs easing moves consisted largely ofcutting interest rates, expanding tender volumes and lengthening

the duration of its refinancing operations. For this reason it isrelatively simple for the ECB to syphon liquidity out of the marketswhen these operations expire. Purchases of covered bonds(Pfandbriefe) and sovereign debt that served to stabilise thesemarkets and that were sterilised accordingly (i.e. the resultantincreases in liquidity were subsequently drained from the system viaother measures) played an only minor role. The programme to buyPfandbriefe worth EUR 60 bn has been wrapped up and thegovernment bond purchases currently total only slightly less thanEUR 85 bn.

All in all, we expect the ECB to start raising key rates in the secondhalf of the year. By year-end the ECBs refi rate could stand at

1.75% and rise further in 2012, provided that the euro does notpersistently soar to new highs.

500

1,000

1,500

2,000

2,500

07 08 09 10 11

Fed

ECB

Central bank balancesEUR bn & USD bn, resp.

Sources: Fed, ECB 28

0

1

2

3

4

5

6

99 01 03 05 07 09 11

Refi rate

3M rate

%

Sources: ECB, DB Research

ECB: Key rate & 3M rate

27


11/12

Outlook 2011

February 14, 2011 11

Inflation: Stable core rate

Inflation ran moderately in 2010. Worries about a possible surge inthe inflation rate proved to be just as unfounded as those aboutdeflation. At year-end 2010, the rate was 1.7% and it increased to1.9% in January being driven by higher prices for heating oil andfuels in particular. The annual average for 2010 was 1.1%. Theadjusted core inflation rate, which strips out energy prices, wasstable last year at close to 1%, thus falling slightly below the long-term average. Price drivers (possible exceptions being energy andfood) are not on the horizon despite GDP growth that is still faroutstripping its potential since, according to OECD calculations, theeconomys capacities are still being substantially under-utilised andwage growth remains moderate. For this reason we look for theinflation reading to hover at around 2% in 2011 and remain in checkat about 1 % in 2012. In our forecast we assume that the oil pricewill increase only moderately, averaging USD 97 per barrel in 2011and inching up to USD 98 per barrel in the following year.

Whither financial markets?It is most difficult at present to forecast yield performance since thecurrent readings are certainly not fundamental equilibrium levels onaccount of the central bank purchases of government bonds, in theUS in particular, and the unbroken flight to quality. Thus the outlookhinges of course not only on the shape of growth and inflation goingforward, but also to a considerable extent on the development of thespecial factors discussed earlier: whether the Fed will complete itsannounced quantitative easing programme and how the euro crisiswill play out.

In our baseline scenario we assume that no major eurozoneeconomy will have to seek a bailout via the European rescue

package (European Financial Stability Facility EFSF). It followsthat the flight to quality is likely to slow, with the high yield premiumsdemanded for problem sovereigns declining as a result. However,this will probably take place only very slowly and yield spreads arelikely to remain very high in comparison with the pre-crisis levels,since the spreads are mainly being shaped by how the marketsassess the efforts and success of the problem countries inconsolidating their finances. The financial aid for Greece and Irelandhas only bought time for these economies. It is still absolutelyessential that these countries consolidate their public finances in asustainable and, above all, confidence-building manner.

Since the boom in the German economy is set to continue and real

returns of about 1% at present can really not be regarded asnormal, we believe that German yields will increase in the courseof 2011 also against a backdrop of tightening US interest rates. Atend-2011 German paper could yield around 4%.

Public finances: Maastricht in sight

The burgeoning recovery and the upswing in the labour marketshould provide relief for public budgets in 2011 as already in 2010.Given the cyclical forces and a half percentage point reduction ofthe structural deficit we think that the general government deficitcould realistically shrink to about 2 % of GDP. This means thatGermany would fall back into line with the budget criterion of the

Stability and Growth Pact already in the course of this year.

0

1

2

3

4

5

6

7

8

80 84 88 92 96 00 04 08

%

Yield on 10Y governmentbonds minus inflation

Real returns


-1

0

1

2

3

4

07 08 09 10 11

Total

Excl. energy

% yoy

Source: Federal Statistical Office

Consumer prices

29

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

05 07 09 11

US

DE

%

Source: DB Research

10Y government bond yields

30

0

100

200

300

400

500

600

700

800

900

1,0001,100

09 10 11

PT

IE

ES

GR

IT

EMU: Yield spreadsVs. German Bunds, basis points

Source: DB Research 31


12/12

Current Issues

12 February 14, 2011

Stepping on the debt brake

Part of the budget improvement in 2011 will be driven by theausterity package, which calls for a consolidation volume of aroundEUR 80 bn from 2011 to 2014 and which was launched to complywith the debt brake anchored in Germanys Basic Law. The debt

brake limits new structural debt from 2016 to no more than 0.35% ofGDP. For the current year the austerity packages consolidationvolume is set to hit over EUR 11 bn, or roughly 0.4% of GDP, thanksto higher revenues (e.g. cutbacks in energy tax breaks, fillips fromthe aviation tax and tax on nuclear fuel rods) and expenditurecutbacks (e.g. setting off the parenting benefit against unemploy-ment benefit II, reducing the parenting benefit, abolishing theheating cost component in the housing benefit and saving onadministrative costs).

The government debt ratio, which came to about 66% of GDPbefore the outbreak of the crisis, is therefore likely to peak at around74% of GDP in 2011 and decline noticeably to less than 70% by2016. This performance differs positively from that in other eurozonecountries, whose new debt will be far higher than in Germany andwhose debt ratios will temporarily continue to climb. According toEuropean Commission calculations, the public debt level is set toincrease by a further almost 10 percentage points in Spain by 2012,to 73%, while the readings in France and Portugal increase from83% to around 90% and in Ireland and Greece by 17 percentagepoints, to 114% and 156%, respectively.

Bernhard Grf (+49 69 910-31738, [email protected])Tobias Just (+49 69 910-31876, [email protected])Jochen Mbert (+49 69 910-31727, [email protected])Stefan Schneider (+49 69 910-31790, [email protected])

40

60

80

100

120

140

160

ES DE FR PT IE IT GR

2010

2011

2012

Public debt% of GDP

Source: European Commission 34

60

6264

6668

7072

74

76

-4.0-3.5-3.0-2.5-2.0-1.5

-1.0-0.50.00.5

07 08 09 10 11

Budget balance (left)

Debt (right)

Public finances% of GDP

Sources: Deutsche Bundesbank, DB Research 33

Copyright 2011. Deutsche Bank AG, DB Research, D-60262 Frankfurt am Main, Germany. All rights reserved. When quoting please cite Deutsche BankResearch. The above information does not constitute the provision of investment, legal or tax advice. Any views expressed reflect the current views of the author, which donot necessarily correspond to the opinions of Deutsche Bank AG or its affiliates. Opinions expressed may change without notice. Opinions expressed may differfrom views set out in other documents, including research, published by Deutsche Bank. The above information is provided for informational purposes onlyand without any obligation, whether contractual or otherwise. No warranty or representation is made as to the correctness, completeness and accuracy of theinformation given or the assessments made.In Germany this information is approved and/or communicated by Deutsche Bank AG Frankfurt, authorised by Bundesanstalt fr Finanzdienstleistungsaufsicht.In the United Kingdom this information is approved and/or communicated by Deutsche Bank AG London, a member of the London Stock Exchange regulated bythe Financial Services Authority for the conduct of investment business in the UK. This information is distributed in Hong Kong by Deutsche Bank AG, Hong KongBranch, in Korea by Deutsche Securities Korea Co. and in Singapore by Deutsche Bank AG, Singapore Branch. In Japan this information is approved and/ordistributed by Deutsche Securities Limited, Tokyo Branch.In Australia, retail clients should obtain a copy of a Product Disclosure Statement (PDS) relating to any

financial product referred to in this report and consider the PDS before making any decision about whether to acquire the product.Printed by: HST Offsetdruck Schadt & Tetzlaff GbR, Dieburg

ISSN Print: 1612-314X / ISSN Internet and e-mail: 1612-3158
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