MNI INTERVIEW: Court Ruling Shaves 0.5% From German GDP-Demary

Last week’s Constitutional Court decision to prevent Germany’s government from redirecting EUR60 billion of Covid emergency measures will reduce GDP by around 0.5% next year, a leading economist told MNI.

While the government could replace spending for 2025 by seeking an exception from debt brake borrowing rules if it obtains two-thirds support in parliament, the funds for next year are gone and plans for EUR200 billion of energy subsidies for industry over the next five years also in doubt, Markus Demary, senior economist at the German Economic Institute (IWH), said in an interview.

“We think it could impact growth negatively by as much as one-half percentage point next year. Only then will we know where investment demand has slowed down, and whether it will slow down further,” Demary said. Germany’s economy was expected to shrink by around 0.3% before returning to low positive growth in 2024 and 2025. (See MNI INTERVIEW2: Debt Limit A Brake On German Economy-Bofinger)

While consumption is more or less stable, Germany still needs investment for growth, and company plans are being delayed by high interest rates, particularly in construction, Demary said.

“The implications is that for important future investment for Germany - making our industry more climate neutral, more competitive - they cannot find financing,” he said. “Before we can have private investment we need public investment, especially in infrastructure.”

WAGE PRESSURE

Meanwhile German companies are contending with tight labour markets and a shortage of skilled labour, he said. (See MNI INTERVIEW: Wages Set To Refuel German Inflation-ZEW Chief).

“We are in a kind of wage-price spiral while inflation is going down. We’ve gone from pandemic-induced low demand, followed by higher energy crisis-induced energy costs, followed by higher wage demands, and for some companies these wage demands could prove problematic. And we are now seeing insolvency rates increasing, having stagnated for a very long time.”

The eurozone as a whole faces a period of more persistent price rises, with core inflation providing stubborn, Demary said, though he added that Europe’s economy could handle further rates hikes if necessary, and that moderate levels of inflation would help to mop up excess liquidity and calm markets.

“We’re back in the old world of having moderate inflation, slightly below the inflation target, where monetary policy has to be a little tougher,” he said.

“After such a long period of expansionary monetary policy and high levels of liquidity markets have become so sensitive to negative developments that it’s a problem. If we have moderate inflation for some years […] hopefully liquidity will normalise too. In this sense inflation also has some positive effects - not at very high levels, but certainly at around 2.5-3%, for example.”

RATES TO STAY HIGHER

Even if projected inflation does undershoot the European Central Bank’s 2% target in 2026 as September’s staff macroeconomic projections suggest it might, this would not be a clear signal to policymakers to cut rates, Demary said, though he noted that prices of tradable goods are coming down relatively quickly in response to supply-side easing, and reduced government spending could bring inflation down marginally in Germany.

“Inflation expectations have been elevated for a year or two now, which limits the possibility that the ECB can lower interest rates, or makes it unnecessary,” he said, “The question still is: What is the neutral rate of inflation? And we don’t know the answer to that yet.”