Pioneer’s Tanguy Le Saout and Andrea Brasili ponder the effects of German elections

Tanguy Le Saout, head of European Fixed Income and Andrea Brasili, senior economist at Pioneer Investments have considered the implications of the latest German elections.

Germany went to the Parliamentary vote on September 22 with the economy in a good shape: the Gross Domestic Product (GDP) grew again in the second quarter and brought the more significant year-on-year rate back into positive territory. Germany has been the first country, among the main European economies, to fully recover from the crisis as GDP rose to new record highs.

The data break-down provided even more upbeat evidence, as the main support came from domestic demand, notably investments in such cyclical
sectors as plants and machinery. Exports’ good contribution is a recurrent
pattern but also consumer spending, which is usually the weak component,
added to overall growth in the second quarter.

Data suggest that the economy is poised to regain reasonable rate of growth next year, although the third quarter is expected to be less strong based on early projections. The IMF pointed out in its August review that business investments have eventually been affected by the euro crisis and the related uncertainty should recede to let Germany’s economic growth regain the faster track. Our current forecast is conservative and sees GDP up a modest 0.5% for the entire 2013 and 1.7% and 2.0% in 2014-2015 respectively. In this backdrop we expect inflation to remain under control, although the German CPI is likely to stay above the Eurozone average (but below 2% year-on-year, which is a threshold for price stability also for the ECB policy agenda).

A Prospective Structural Change: Consumer Spending’s Share of GDP set to Rise

The buoyant labor market helped Germany move from being Europe’s laggards to retaking its role of economic powerhouse. Despite the global recession and then the euro crisis, Germany’s unemployment is still standing at its postunification lows. As textbooks would expect in these conditions, wage growth set by the latest major national contracts exceeded inflation for the first time in years; this wealth effect increases the chance that domestic consumer spending will support overall growth as much as foreign demand.

Nevertheless, the foreign channel’s contribution remains notable. This share has been declining but at a far lower speed than for other developed countries.

The need for further reforms: IMF assessment and our view

In its August report, the IMF reiterated its call on Germany to diversify the
sources of growth also in an effort to give the Euro area more political stability.

The country fared much better than the rest of Europe throughout the most
recent crises, but the IMF report argues that its growth potential is still modest at around 1.25% year-on-year and is primarily capped (more severely in the future) by the ageing population, a declining labor force and low private and public investments. Some measures to enhance the participation rate has already been implemented and the country posted a net migration flow in 2012, although IMF analysts suggest that more should be done. In our opinion other reforms should aim to make non-manufacturing sectors more efficient and productive, helping it to close the still wide productivity gap with manufacturing (“the export machine). Less regulation, starting with the retail sector’s opening hours, could be one of the first area of intervention.

A further area of reforms that, in our opinion, Germany should face is strictly related to Germany’s role in eurozone integration and is covered in the following section, where we comment the fresh election outcome.

The election results and the implications for Europe

The incumbent chancellor Angela Merkel’s sweeping victory, actually the
largest since the success of Helmut Kohl in 1990 in the wake of  reunification, was largely expected. Also rather predictable was the disappearance from Parliament of the junior coalition partner in the last legislature, the liberal Free Democrats Party (FDP). The consensus view is that Merkel’s Christian Democratic Party (CDU) may now seek a “grand coalition” with the main Social Democratic Party (SPD) just as in the 2005-2009 legislature.

The SPD does not look enthusiastic about posing once again as a junior coalition partner, while the alternative option of a coalition between the CDU and the Greens’ environmental party is seen as unlikely due to the two sides’ sharply different backgrounds. In fact, outsiders of German politics see the Greens as an anti-establishment lot, keen on pursuing radical policies.

However this old “cliché” may be shed by the emergence of a “pragmatic” wing within the movement, which has been shaped by the experience in coalition governments (mostly SPD-led) at both federal and regional level. For its part, the CDU has embraced some of the Greens’ favorite policies, such as the dismantling of nuclear power stations, and may not object to inserting more environmentally-conscious measures in the future government agenda.

Based on past experience, coalition talks may need as long as a full month to be finalized. However, negotiations will likely focus on domestic policies, while Europe-wide issues may not be on top of the agenda for the time being. 

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