Global Insight Perspective

Significance

The quarter-on-quarter GDP growth rate of 0.6% understates underlying growth momentum due to a likely temporary de-stocking and a corrective slowdown in investment growth.

Implications

The component breakdown shows robustness across the board, with even private consumption recovering and net exports providing GDP with a positive stimulus. Domestic demand has now developed sustained momentum of its own, which is unlikely to falter in the wake of the VAT rise in early 2007.

Outlook

Our most recent November interim forecast expects average GDP growth in 2006 to be 2.5% (unadjusted: 2.3%), but the underlying strength revealed by the third-quarter data suggests that yet another slight upward revision to 2.6%, or even 2.7%, is in the offing. The robustness of this economic recovery has already led to an increase in our 2007 growth forecast from 1.2% to 1.7% over the past two months, and the risk to next year’s forecast continues to be to the upside.

According to detailed data from the Federal Statistical Office (FSO), real GDP growth in the third quarter of 2006 was 0.6% quarter-on-quarter (q/q), adjusted for seasonal and calendar factors. This confirms the preliminary figure released on 14 November, and follows growth of 1.1% q/q in the second quarter (revised up from 0.9%), 0.8% q/q in the first quarter (revised up from 0.7%), and 0.4% q/q on average throughout 2005. Year-on-year (y/y) growth in the third quarter of 2006, again calendar-adjusted, was 2.8%, which compares to 2.7% in the second quarter, 1.9% in the first quarter, and the most recent low point of 0.2% in late 2004. A moderate negative calendar effect—there was one less working day relative to the third quarter of 2005—depressed the unadjusted y/y rate to 2.3%.

Net Exports Make Solid Contribution to GDP as Trade Growth Accelerates Again

The breakdown by individual expenditure component that is now available shows that net exports provided a healthy contribution to quarterly GDP growth of 0.4 percentage point in the third quarter, having had no net impact in the second quarter and a positive effect of 0.3 percentage point in the first quarter. Both export and import growth accelerated considerably, from 0.8% q/q each in the second quarter to 4.2% and 3.6% q/q, respectively. The monthly merchandise trade data had shown a sharp spike notably in September, with export growth outpacing import growth. Although part of this was due to the sudden import price decline in the wake of the oil-price drop in August/September, even the price-adjusted measure in the national accounts statistics has now borne this out. Related indicators, such as export orders, had also indicated a recovery of demand from abroad following a temporary slowdown during the second quarter. At the same time, improving domestic demand has ensured that real imports have not fallen too far behind, which is remarkable in view of the drain on consumer purchasing power from still-high oil-price levels throughout most of the third quarter.

Meanwhile, exports on their own continued to be boosted by resilient global demand and the lack of a further significant appreciation of the euro so far. Furthermore, German exports have demonstrated a tendency in 2006 to raise their world market share because of improved price competitiveness (following cost/wage reductions in recent years) and the fact that many German goods (notably plants and machinery) are particularly sought-after by oil-producing countries which are flush with funds due to the high oil prices.

Domestic Demand Increasingly Boosted from All Sides

Domestic demand was officially responsible for only a third (0.2 percentage point) of overall quarterly GDP growth of 0.6% in the third quarter. This was largely due to a sharp unwinding of inventories, however, which subtracted growth of 0.5 percentage point. This may partly reflect a reticence on the part of firms to re-build inventories of raw materials, given the high prices prevailing at the time, preferring instead to produce from existing stock wherever possible. As a result, domestic demand minus inventories, which last suffered a setback in the fourth quarter of 2005, has now shown solid increases of 0.9%, 0.6%, and 0.7% q/q in the first three quarters of 2006, respectively.

Real fixed investment growth slowed to 0.8% q/q in the third quarter, following strong increases in the second half of 2005 and the first half of 2006. This partly reflects a corrective weakening after an extremely strong second quarter (growth during which has been revised up further to 4.4% q/q). The slowdown extended to both construction (up 0.8%) and equipment spending (up 0.7%). In the case of the former, this is partly explained by weather-related unwinding in the second quarter (which had boosted construction growth to 5.8% q/q). In addition, monthly indicators showed softer demand in the construction sector in August/September, having still posted growth of 7% y/y during the first half of the year. By contrast, the monthly data on orders in the investment goods industry, which had shown slowing growth in the second quarter, has highlighted a fresh surge in the July-September period, arguing for a renewed rebound in equipment spending in the upcoming fourth quarter. As before, investment in equipment continued to be helped by the introduction of improved depreciation schedules at the start of 2006, which can be taken advantage of until the end of 2007 and lower the tax burden for investing firms.

Private consumption posted an unexpectedly firm gain of 0.7% q/q, following the equally unexpected decline of 0.2% q/q in the second quarter. Quarterly swings have been unusually pronounced since late 2004. The average increase over the last eight quarters since the fourth quarter of 2004 has been 0.2% q/q. Although very modest by international comparisons, this does represent an improvement compared to the clear downward trend of real consumption levels between mid-2001 and late-2004. The mounting burden from high oil prices has thus been shouldered more easily in recent quarters, which can be linked to the declining trend for unemployment since mid-2005. Unconvincing retail sales data in recent months has not been a good indicator for third-quarter consumption, partly as car sales—which are not included in those statistics—have shown above-average results of late. Not even the ongoing concerns about the ability of the new “grand coalition” government to introduce successful structural reforms, and the resulting unpopularity of the administration in the polls, have prevented a rise in consumer spending. Further improvements in consumer confidence, encouraging labour market developments, and the boost from additional purchases ahead of the increase in value-added tax (VAT) in January 2007 should translate into healthy consumer spending also in the final quarter of 2006.

Public consumption data revealed a similar pattern to that for private consumption, recovering to growth of 0.9% q/q following a 1.0% q/q decline in the second quarter (which was even revised down from a 0.2% fall). Public consumption, which had indeed declined in absolute terms in 2003-04 before stabilising in 2005, thus appears to be cautiously returning to an upward trend again now. This should continue to be restrained, however, by the ongoing pressure from structural deficits and the government’s fiscal-tightening efforts scheduled especially for 2007.

The data on overall domestic demand also now shows that a recovery of the domestic economy indeed already began in the second quarter of 2005, and that it has broadened and strengthened during 2006. Distorting effects from changes in inventories apart, this strongly suggests that this upswing will be sustained in coming quarters. The VAT rise will still provide a dent in the first quarter of 2007, but this is most likely to have been overcome by the second quarter.

Outlook and Implications

Following the latest upward revisions to the data in the first half of 2006, GDP growth can safely be said to have accelerated quite strongly in recent quarters compared to a more moderate pace in 2005. The current situation thus matches—in hindsight—the very encouraging outlook portrayed by leading indicators since the second half of 2005. In late 2005, surging imports and very weak private and public consumption (the latter also due to temporary political uncertainty after the elections) had briefly restrained growth once more, but the first two quarters of 2006 saw the best economic growth performance since the first half of 2000, and the third quarter is not far behind when the football World Cup and weather effects that gave the second quarter an added growth boost are accounted for. The rising underlying momentum of economic activity is also shown by the broad-based nature of the upswing in the third quarter, with exports, investment, and private consumption all contributing. That net exports have not boosted GDP growth that much in 2006 so far is simply due to the boost given to imports by strengthening domestic demand. Although domestic demand in 2006 so far has been mainly driven by investment, private consumption is no longer the drag that it was throughout 2002-05, helped by falling unemployment. Since fairly little weakening of global demand is in sight at present, net exports will hardly become a burden for German growth in the near term either.

Global Insight’s November interim forecast for 2006 GDP growth of 2.5% (equal to 2.3% unadjusted) has been confirmed by the third-quarter release, and there is even a fair chance of a slight further upward revision to 2.6% or 2.7%. The robustness of this economic recovery—supported by sharply declining unemployment since the second quarter and due to receive another boost by pre-VAT-rise effects in late 2006—is now likely to also lead to higher GDP growth in 2007 than previously expected. Our November interim forecast predicts growth next year of 1.7% (1.5% unadjusted), up from just 1.2% projected in early October

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

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