MNI INTERVIEW: Deeper German Recession Despite Rescue Package

German inflation may fall faster than expected over the coming year but the country could also enter a deeper-than-expected recession as the government’s EUR200 billion plan to counteract higher energy costs fails to boost household spending, the head of European economic policy at the Macroeconomic Policy Institute (IMK) told MNI.

Despite government support, Germans on average incomes will still be forced to cut discretionary spending as energy prices sap their funds, Andrew Watt said in an interview, adding that the economy could contract by 1% next year, more than twice as much as anticipated in last week’s joint assessment published on behalf of the Economy Ministry. (See: MNI INTERVIEW: Germany Faces Permanent Loss of Competitiveness)

“They haven't said that they will definitely spend EUR200 billion,” he explained. “That figure is, perhaps incautiously, a headline number which may or may not come to pass.”

Despite Finance Minister Christian Lindner’s pledge to return to strict spending limits next year, Germany’s “Traffic Light” coalition government is likely to keep its spending promises, Watt said, with the left-of-centre Social Democrats and the Greens wary of reneging on welfare and environmental pledges.

“They’re going to borrow off-the-books. There are legal get-arounds, but from an economic point of view it’s just additional government borrowing. Everybody knows that they're going to have to spend more in the coming year,” said Watt, adding that the debt-brake restricting structural budget deficits is effectively “dead.”

INFLATION PEAK THIS YEAR

Inflation could peak at 7.8% this year before falling to 5.7% in 2023, well below the 8.8% foreseen in the joint assessment, according to Watt. Headline numbers have a large backward-looking component, and monthly inflation could be close to zero by the end of next year, he said, arguing that the European Central Bank should avoid chasing Federal Reserve rate hiking.

"The noises that are coming out - we have to break inflationary expectations, we have to follow the Fed, which I think is the silliest argument, because conditions in the U.S. are different - are worrying, because the annual average inflation figures are misleading," he said.

“The worry is that by the time people stop chomping at the bit to raise rates the damage will be done. The ECB needs to take a bit of a pause now to wait and see what happens over the winter.”

Eurozone wage increases are still lagging inflation, despite an Oct 1 rise in Germany’s minimum wage from EUR10.45 to EUR12.00 per hour, said Watt, who was also critical of the weight placed by some ECB policymakers on the need to return to the so-called “neutral” level of interest rates, something which is hard to determine even in normal times.

But the ECB is unlikely to have its policy room curtailed by legal action by German plaintiffs against the ECB’s new Transmission Protection Instrument, which will probably be rejected by the German Constitutional Court, he said.