The economic situation in Germany in April 2022 – new outlook for the German economy^[1]

• The Russian war of agression in Ukraine poses substantial risks to the German economy. However, it is difficult to quantify effects at this stage as these will very much depend on the duration and intensity of the war.
• Since the beginning of the military invasion, there have been extreme price increases in energy and raw materials. Trade flows and supply chains are also affected. As a result, uncertainty about future economic developments remains very high.
• Since the common economic indicators are published after a one to two-month delay, the war in Ukraine has hardly been reflected in them so far. Most recently (i.e. from the month of February), the indicators have shown mixed trends in industrial activity, while developments in the service sectors have continued to be strongly influenced by the pandemic.
• Both industrial output (+0.1%) and construction output (-0.7%) saw weak growth. There was also a contraction in new orders in the manufacturing sector (-2.2%). However, hardly any of the effects of the war in Ukraine are included in these data. The outlook for the coming months is therefore subdued.
• Retail sales rose slightly in February despite 2G rules still being in place. Most recent figures show that the pre-crisis level of February 2020 was surpassed considerably. In the coming months, the inflation rate driven by energy prices and the uncertainty caused by the Russian intervention in Ukraine are likely to weigh on private consumption.
• In March, the inflation rate grew from 5.1% to 7.3%. Prices for energy and also for food were the main reason for the noticeably higher rate of growth in the price level. In contrast, the core rate, which excludes these two volatile price components, increased at a much slower pace.
• The positive trend on the labour market continued in March. The Russian attack on Ukraine has not reflected in the data so far. In seasonally adjusted terms, registered unemployment once again dropped March, and employment again increased noticeably in February. Short-time work continued to fall slightly in January, down to around 0.65 million.
• The Joint Economic Forecast and the German Council of Economic Experts have drafted initial assessments of the effects of Russia’s war of aggression in current forecasts. The future development of the economy is currently being influenced by a very high level of uncertainty about the further course of the war.

STAGNATING INDUSTRIAL ACTIVITY AND UNCLEAR OUTLOOK
Economic developments in 2022 have been dominated by the Russian war of aggression in Ukraine since the end of February. Most economic indicators do not yet reflect the effect of the war, as these are published with a one to two-month delay. The current reporting month of February presented a mixed picture: industrial production saw only a flat development, and new industrial orders declined noticeably. By contrast, foreign trade recovered after a weak start to the first quarter. Retail sales also rose slightly despite ongoing restrictions related to the coronavirus pandemic. Nevertheless, there are still many unresolved questions: how are the sanctions imposed on Russia affecting foreign trade? What effect are the high energy prices and potential new supply shortages having on production? And how are consumers and investors dealing with the increased uncertainty? Initial answers to these questions will be available next month, when hard economic indicators for the reporting month of March will be presented for the first time.

As of today, only survey-based sentiment indicators are available. These show, for example, that the ifo business climate declined significantly in March. However, this was primarily due to the sharp decline in business expectations. Companies’ assessments of the current situation were hardly any worse than in the previous month. In contrast, the Purchasing Managers Index showed a milder reaction to the Russian war in the month of March.

However, the inflation rate remains a cause for concern: in March 2022, it stood at 7.3%, largely driven by a spike in energy prices following the outbreak of war on 24 February 2022. It is hard to make any reliable predictions about the further development of the price level because neither the duration nor the outcome of the war can be foreseen at this point. Since Germany imports the bulk of its gas supplies from Russia, there is a high risk of increases in the price of gas. While gas prices declined again in March, they did so from what was already a very high level shortly before the Russian war of aggression began. Currently, they are still more than four times higher than their long-term average. Germany will have to pay significantly more for energy in 2022 than in years previous.

GLOBAL ECONOMY CONTINUES TO GROW
Until the outbreak of war in Ukraine, there were still positive signals coming from the global economy. Industrial output, for example, rose 1.8% from December to January. Global trade stagnated in the same month, but there had been substantial increases in the three preceding months. The sentiment indicator of S&P Global (formerly IHS Markit) also increased again in February and at 53.4 points was above the growth threshold of 50 points.

GERMAN FOREIGN TRADE: EXPANSION WITH UNCERTAIN PROSPECTS
In the last month before the war in Ukraine, German foreign trade expanded strongly again. In February, nominal exports of goods declined by 6.4% compared to the previous month (seasonally adjusted). While there was weak growth in January, the two-month comparison still shows a rise of 0.8%. As export prices rose by 1.0% in February, the real increase in exports of goods is likely to have been somewhat lower.

Similar to the trend in exports, nominal imports of goods also increased significantly in February, growing by 4.5% in seasonally adjusted terms. Here, too, the sharp decline seen in the previous month resulted in an almost constant two-month comparison (+0.1%). Given the substantial rise in import prices, growth is likely to have been weaker in real terms.

It is expected, however, that this positive overall momentum will be significantly curbed by the Russian war of aggression in Ukraine. As early as February, German exports and imports to and from Russia had already dropped by -6.3% and -7.3% respectively, contrary to the overall positive trend. As a result of the sanctions imposed, Russia is more or less cut off from global trade, which could lead to new supply bottlenecks and shortages of certain raw materials. Overall, global uncertainty has increased significantly. The first hard data covering the effect of the sanctions on German imports and exports will not be published until early May. Currently, only indicators of sentiment are available. For example, the ifo export expectations dropped by 19.3 balance points in March. To put this figure into perspective, during the first coronavirus-related lockdown in spring 2020, the ifo export expectations plunged by around 50 balance points within two months. The S&P Global/BME Purchasing Managers Index also dropped sharply in March, sinking to an 18-month low.

One major effect of the war in Ukraine on Germany is the sharp rise in import prices. In 2022 as a whole, the terms of trade (ratio of export prices to import prices; “real exchange ratio”) are therefore likely to deteriorate significantly, and the current account surplus is also expected to be lower due to the higher costs of energy imports. The outlook for German foreign trade has deteriorated considerably as a result of the Russian invasion of Ukraine.

FLAT DEVELOPMENT OF INDUSTRIAL ACTIVITY SHORTLY BEFORE THE OUTBREAK OF WAR
In February, output in the goods-producing industries rose by only 0.2% over the preceding month. In the construction sector, the strong increase in January (+5.9%) was followed by a decline of 0.7%. This drop was offset mainly by a sharp rise in energy production, which recorded an increase of 4.9% as a result of the storms seen in February. At 0.1% growth, industrial output virtually stagnated. However, there was a marked decrease in output in the key sectors of mechanical engineering (-2.1%) and vehicles & vehicle parts (-1.3%). This downward trend was countered by increases in the pharmaceutical products (+15.6%) and electrical equipment (+1.4%) sectors.

New manufacturing orders fell by 2.2% between January and February, ending the upward trend seen since October. Demand for capital goods (-2.8%) and intermediate goods (-1.9%) declined in particular, while orders for consumer goods (+0.7%) were able to cushion the overall decline somewhat.

This negative growth was mainly due to falling demand from abroad, with similar delines recorded for eurozone countries (-3.3%) and non-eurozone countries (-3.4%). Particularly strong declines in orders were recorded in chemicals (-4.9%), metal products (-22.3%), mechanical engineering (-5.3%) and vehicles & vehicle parts (-3.4%). Overall, however, the level of orders on the books remains very high. Together with industrial output, which has remained virtually unchanged, the decline in new orders points to an economic slowdown. In view of the Russian war of aggression in Ukraine, economic development is likely to slow down even more in the coming months.

RETAIL SALES UP SLIGHTLY
After stagnating in January (0.0%), retail turnover (excluding vehicles) is expected to have risen 0.3% in February from the previous month, despite 2G rules still being in place. They were down 2.3% in December 2020 due to stricter regulations. The figure for December was thus significantly adjusted upwards by the Federal Statistical Office. Consequently, recent sales were 4.4% above their level in the pre-crisis month of February 2020. New car registrations by private owners dropped considerably in October, down 18.3% following weak growth in the two preceding months.

Whereas the pandemic has so far been the main reason for the slump in consumer spending, the high inflation rate and uncertainty related to the Russia-Ukraine conflict are now the major factors affecting private consumption. The two common leading indicators show that uncertainty among private consumers has increased significantly: on balance, the ifo business expectations for retail trade deteriorated strongly in March. The GfK’s consumer sentiment index also suggests that the situation will greatly deteriorate in April.

The consumer price level rose strongly, up 2.5% in March over the previous month (February: +0.9%). The inflation rate, i.e. the year-on-year development of the price level, increased in March by 2.2 percentage points to 7.3%. This was mainly due to significant increases in energy prices (+39.5%; previously +22.5%) and food prices (+6.2%; previously +5.3%). The further development of the Russia-Ukraine war will have a significant impact on energy prices. For example, the price of crude oil, one of the key indicators, initially climbed to almost $130 per barrel against the backdrop of the Russian invasion of Ukraine; it currently stands at around $100 per barrel. These are all-time highs not seen since the financial and economic crisis of 2007/08. A quick easing of the current price levels is not expected in the foreseeable future. Core inflation (excluding energy and food) in March amounted to 3.4%.

POSITIVE TREND ON THE LABOUR MARKET TO CONTINUE IN MARCH
To date, the labour market has not yet been affected by the Russian war of aggression in Ukraine. The consequences of the war are only likely to become apparent after a delay. Unemployment and underemployment both fell again in March, dropping by 18,000 and 23,000 persons respectively (after adjustment for seasonal effects). According to the unadjusted figures, registered unemployment fell by 66,000 to now stand at 2.36 million people. Compared with the same month in the previous year, the number of unemployed persons was down by 465,000. The positive development in gainful employment and jobs subject to social security contributions also continued. Employment grew again strongly in February, rising by 34,000 after seasonal adjustment. According to the unadjusted figures, there were 45.1 million people who were gainfully active, which is an increase of 678,000 year-on-year. In January, employment subject to social security contributions increased sharply, up 71,000 persons compared to the previous month. According to projections by the German Federal Employment Agency, the number of people in short-time work fell again slightly in January, dropping to 0.65 million. The important indicator for short-time work notifications showed that the figures recorded in March were lower than they should be due to the short-term extension of the regulations on short-time work; it is therefore of practically no significance this month. However, it is to be expected that there will be a moderate increase in short-time work. The leading indicators from ifo and IAB suggest that the labour market will continue to see robust growth without a significant increase in job losses. However, the ifo barometer signals a lower willingness among companies to hire new employees, once again reflecting the high level of uncertainty in the economy since the start of the war. This is similarly reflected by the low increase in the number of reported vacancies at the employment agencies. The overall number of vacancies however remains at an all-time high. It is therefore to be expected that the robust development on the labour market will initially continue, albeit at a slightly reduced momentum.

CURRENT ECONOMIC FORECASTS
Die Joint Economic Forecast (DIW Berlin, ifo München, IfW Kiel, IWH Halle und RWI Essen) and the German Council of Economic Experts recently published their spring projections.

The Joint Economic Forecast expects GDP to grow by 2.7% this year and by 3.1% next year. With the pandemic subsiding, there would have ordinarily been a strong economic recovery emerging. However, this recovery is initially being slowed down by the outbreak of war in Ukraine. The pre-crisis level of economic output will therefore not be reached again until the third quarter of the current year. Consumer prices will rise by +6.1% in 2022, representing the strongest increase in four decades. In 2023, the inflation rate of +2.8% will remain well above the average rate seen since German reunification. The forecast contains major uncertainties stemming from the further course of the military conflict in Ukraine and its political consequences. For this reason, economic research institutes have analysed the alternative scenario of an immediate embargo on Russian oil and gas deliveries to the European Union. The analysis shows that such an embargo would plunge the German economy into a severe recession. As a consequence, gross domestic product would grow by only 1.9% this year and decline by 2.2% in the next. The inflation rate of +7.3% in 2022 and the +6.5% year-on-year increase in the core inflation rate would again significantly exceed the high values from the base scenario.

While it still projected a strong growth rate of 4.6% back in the autumn, the German Council of Economic Experts has now significantly revised its growth forecast for 2022 down to +1.8%. The coronavirus pandemic, the soaring prices for raw materials and energy, and the outbreak of war in Ukraine were cited as the reasons for this downward revision. According to the Council’s estimates, the inflation rate will be +6.1% in 2022 (Annual Report 2021: 2.6%) and fall back to +3.4% in the following year. In addition to the sharp rise in energy prices, the Council also points here to some wage pressures and rising food prices. However, quotations on the futures markets for oil and gas indicate that the upward pressure on energy prices will ease over the course of the year.

The new forecasts of the Joint Economic Forecast and the Council of Economic Experts are based on first assessments that take into account the effects of the Russian war of aggression. Economic development is currently affected by the high level of uncertainty about the further course of the war. The Federal Government will unveil its spring projection on 27 April 2022.

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[1] The report is based on statistical data that were available as of 12 April 2022. Unless stated otherwise, these are rates of change against the respective preceding period on the basis of price-adjusted figures which have also been adjusted for calendar-day and seasonal variations.