MNI INTERVIEW: German Recession On The Cards - ZEW's Wambach

Germany is likely to slide into recession as high inflation and interest rates, rising financing costs, and expensive energy assail an economy still not fully recovered from previous shocks, the head of the Leibniz Centre for European Economic Research (ZEW) told MNI.

Despite coming through the Covid-19 and energy crises comparatively successfully, the economy was left with “not much of a buffer” in the event of a downturn, Achim Wambach said in an interview, after the ZEW’s Indicator of Economic Sentiment dipped from 4.1 in April to -10.7 in May - the third downward move in a row, and the current economic situation survey fell 2.3 points to 34.8.

While the country is expected to reach its potential gas storage before winter, securing supplies despite the conflict in Ukraine, shifting from cheap pipeline gas to more expensive liquefied natural gas will force manufacturers to lower usage. A government pledge to cap costs will offer some relief, but Wambach said he doubted their effectiveness over the longer term, making a small but potentially prolonged recession “not unlikely.”

“We have seen a steep increase in interest rates, and there's a high probability that that will have repercussions, that we will run into a recession at some point,” Wambach said. (See MNI INTERVIEW: EU Risks Winter Gas Squeeze -German Energy Head)

STRUCTURAL SHIFT

Germany’s biggest worry is a shortage of skilled workers, he said, and, increased financing costs are already dampening investment in construction in particular, while risks to the financial system “remain on the agenda.”

“Some banks and some insurers [will] run into problems, as customers in search of higher yields withdraw their account," Wambach said.

Over the longer term, German companies face a structural shift in energy costs, he said, adding that the government could end up subsidising electricity prices for industry longer than the planned 2030 cut-off date.

“Electricity prices are expected to be relatively higher in Germany also after 2030 compared to other countries,” he said, calling for a “a European solution” to avoid problems under competition law.

Cheaper energy and other incentives offered by the U.S. Inflation Reduction Act mean German industry will continue to move manufacturing abroad, including to China, he said.

“By now most companies that are invested in China have rewritten their risk strategies - what happens in case geopolitical tensions are increasing, and if there are further interruptions in the supply chain? In some areas this could even lead to more investment in China."

Analysts surveyed by ZEW expect inflation to fall significantly next year, and for the European Central Bank to raise its benchmark rate to 4.0-4.25%. (See MNI SOURCES: Most At ECB See 4% Rate As Only Outside Chance)

Should prices not fall meaningfully, public frustration in could prompt a “much stronger debate [about] what the state can do, and whether companies are not lowering prices sufficiently,” Wambach said.

FISCAL RULES

While last week’s announcement that Federal tax revenues could be EUR30 billion less than expected next year is unlikely to prompt serious discussion over raising Germany’s debt ceiling, the realisation that the government is set to fall some EUR12 billion short of its own climate protection commitments may provoke fiscal policy change.

“We've seen already a debate on whether there should be tax increases,” Wambach said. “The way out for the government so far was the use of [a special investment fund], for example for both military spending and corona relief. For energy transition there are strong opponents, but as the budget gets tighter and tighter, it might be that opponents [of using an investment fund] have a harder time making their arguments.”