Although the analysis is a preliminary one (as detailed data about the individual expenditure components will only be made available on 22 February), the answer is a resounding ‘no’. All the available indications suggest that the fourth-quarter stagnation will prove to be a one-off, and partly due to statistical factors.

The information provided about fourth-quarter growth implies that both net exports and domestic demand failed to provide a positive contribution in late 2005. The FSO press release only makes reference to the external sector by pointing out that most of the year-on-year increase in GDP stemmed from persistently dynamic trade flows. As indicated by monthly trade data, this has not boosted net exports, because imports were particularly strong in late 2005 (notably in December), similar to developments in the second quarter of 2005. As rising real imports tend to be directly related to strengthening domestic demand, this is not a discouraging sign, but an encouraging sign for the outlook in 2006. The temporary downward correction of oil prices during the fourth quarter, raising the purchasing power of domestic consumers and investors, probably helped to boost imports in real terms. At the same time, exports on their own apparently continued to strengthen in late 2005, as the competitiveness of German export goods in global markets, if anything, increased further, along with the weakening euro.

Meanwhile, overall domestic demand broadly stagnated as well, following moderate increases in the second and third quarters (0.2% and 0.4% q/q, respectively, excluding inventory changes). Apparently, declines in private and notably also public consumption offset increases in investment, led in the fourth quarter by construction. These developments had been widely heralded by monthly indicators already. Equipment investment in the industrial sector reached a high in October and then corrected in November/December, while building investment apparently grew strongly throughout the fourth quarter (November construction orders posted an 11-year high, and unusually good weather also helped). Investment in equipment was driven by strongly rising demand until November, but a looming fiscal measure (improved depreciation schedules in 2006/07) likely led to some investment being held back to take advantage of better tax rules in 2006.

Private consumption experienced its fourth consecutive quarter of decline due to the loss in purchasing power from high oil prices and the additional political uncertainty related to the formation of the new government. This was adequately reflected by weak retail sales until the end of 2005. The apparently pronounced weakness also of public consumption could similarly be related to the switch in government that put some expenditure on hold during the transition period. Finally, little can be said about the role of inventories in the fourth quarter, apart from indications that firms may have been reticent to rebuild stocks of raw materials because of their high price levels (instead preferring to produce from existing stocks).

Although the official calendar effect in the fourth quarter—about one working day less than a year earlier—was only about half the size seen in each of the three quarters spanning the period between late 2004 and mid-2005 (which had led to some significant distortions of the quarterly pattern), the calendar adjustment employed may have led to an understatement of underlying growth momentum in the final quarter of 2005.

The calendar constellation in the fourth quarter included several holidays in December that fell on weekends, which means that the calendar adjustment method may have implicitly assumed that firms worked at a normal pace during the week between Christmas and New Year—which is most unlikely—and thus over-adjusted the raw data. This factor should not be held responsible for more than 0.1–0.2 percentage point of fourth-quarter growth, but it will have dampened the headline figure.

Global Insight has previously argued that third-quarter GDP growth (0.6% q/q) adequately reflected underlying developments, with external and domestic demand for once both contributing in roughly equal measure. Stagnation in the fourth quarter of 2005 has been caused by a combination of a surge in imports, an unusually sharp one-off dip in public consumption, a prolongation of the private consumption slump due to record high oil prices and election-related political uncertainty, and finally a technical effect related to the calendar constellation. All of these dampening factors should either correct in the first quarter of 2006 or at least not impact to the same degree.

Furthermore, monthly indicators were mixed during the fourth quarter, but showed a strong upturn in January, notably business (Ifo, PMI) and consumer confidence indicators (GfK). This is also supported by the strong rise in optimism in the thrice-yearly DIHK survey of 25,000 companies that was conducted in January. Current situation, business expectation, and employment intention indicators posted five-year highs, investment intentions an 11-year high, and export expectations even a 20-year high. Increases were broadly based among the four key sectors (industry, construction, domestic trade, and services), with construction advancing the most as it emerges from an 11-year slump.

German companies are currently taking full advantage of the improvements in competitiveness achieved in recent years, with a relatively weak euro also helping. Strong investment in recent months has made the recovery less vulnerable to external risks such as further increases in commodity prices, a marked drop in global demand, or a sharp euro appreciation. There is a continuing demand for structural reforms to sustain this upswing beyond 2006, notably as the 3-point VAT hike in January 2007 threatens private consumption. For 2006, however, there is no reason to deviate from our February interim forecast for GDP growth of 2.0% (equal to 1.8% unadjusted), not least as consumers will bring forward their purchases of large durables, and as the soccer World Cup will deliver some additional impulses in midyear.

Contact: Raul Dary

24 Hartwell Ave.
Lexington, MA 02421, USA
Tel: 781.301.9314
Cel: 857.222.0556
Fax: 781.301.9416
raul.dary@globalinsight.com

www.globalinsight.com and www.wmrc.com