MNI INTERVIEW: Germany Faces Low Investment, Growth - IW Koeln

Germany faces a prolonged period of slow growth and declining market shares, but core inflation is likely to remain high as supply- and energy-driven price rises give way to an upward trend in domestic demand pressures, senior German Economics Institute (IW Koeln) economist Markus Demary told MNI.

Inadequate state spending on infrastructure means firms may take advantage of lighter labour regulation and better green subsidies outside Germany, and. falling levels of corporate investment mean many companies will fail to meet government climate neutrality targets, Demary said in an interview.

“I am concerned that we will experience slower growth over the longer-term because of low investment rates,” Demary said. “Anecdotal evidence suggests they consider it too risky. It’s also problematic because companies have to invest in order to become climate neutral, so we could run into some structural problems.” (See MNI INTERVIEW: Germany Faces Permanent Loss of Competitiveness)

MORE ATTRACTIVE ABROAD

Demary cited the example of Heidelberg Cement, one of the world’s largest building materials companies, which recently launched a carbon capture and storage project at its Brevik plant in Norway, as an example of a German firm bypassing unfavourable local conditions in favour of more attractive business environments elsewhere.

“Companies need infrastructure too,” he said. “They need supply chains for getting hydrogen and transporting carbon dioxide, for example, which is where we need public investment,” he said.

"Companies are considering moving to the U.S. because they get a very, very good environment with low [labour] regulation, cheaper energy and subsidies for greening and becoming sustainable. Maybe there is a reorientation from Germany to the U.S. or from China to the U.S., for example."

Those firms that can afford to may cut prices in response to falling cost-push inflation next year, Demary said, but many others will not. “For some with very small profit margins it’s a question of survival.”

Germany’s labour market remained robust throughout the Covid-19 crisis and recent sharp rises in energy prices, Demary said. So far there is little sign that wage-increase demands will translate into an inflationary spiral, although a shortfall in labour supply could lead to increased bargaining power as seen in the U.S.

STICKY INFLATION

Despite early signs of a slowdown in headline inflation - largely attributable to a combination of falling energy prices and increased efficiency savings - high liquid natural gas prices will mean inflation in Germany will persist above the ECB’s 2% target for several years, Demary said.

Average euro area inflation moderated from 10.6% in October to 10% to November, according to Eurostat’s latest flash data, and from 11.6% to 11.3% in Germany.

But core inflation, currently at around 5%, will stay high for a long period, Demary said. There is also growing evidence that prices will remain elevated even after energy costs fall and imported inflation tails off.

“High inflation rates up to now have been supply-driven and imported. But domestic inflation and the demand-driven inflation path are also elevated above the ECB’s inflation target, and have been gradually increasing. I would say it's an increase in trend inflation for the medium term.”

The ECB could be forced to raise interest rates to around 4%, he said, with inflation stuck at 3-4% over the medium term.

“The upside is that we are back at the traditional task of a central bank of preventing higher but moderate inflation,” he said. “Three-to-four per cent over the medium term, I think these are moderate levels.”