Dismal Q4 won’t derail German economy

Europe’s largest economy fared worse than expected at the end of 2012. But the fourth-quarter contraction will be a quickly-forgotten brief dip. Forward-looking indicators suggest that the euro zone’s economic engine is still humming.

The latest numbers of Europe’s largest economy are nothing to brag about – at least by German standards.  Gross domestic product fell about 0.5 percent in the final quarter of 2012. The drop was significantly larger than most economists had expected. Despite this negative surprise, however, there is no need to lose faith in Europe’s last remaining growth engine.

First, the economy’s performance in 2012 must be seen in the context of the euro crisis. The rest of the currency union is in recession. That Germany has been able to decouple itself partially from its main trade partners is remarkable in itself. Unemployment barely rose, tax revenues are at an all time high, and non-European exports are doing fine. Private consumption, traditionally the weak spot of the German economy, was quite resilient last year. All in all, compared to its peers, Germany’s annual growth rate of 0.7 percent isn’t too bad. In the euro zone, only Estonia and Slovakia fared better.

Moreover, the growth dip at the end of last year will be quickly forgotten. Uncertainty about the future of the euro zone weighted heavily on the German economy.  Despite low interest rates and decent profit margins, German companies shunned investment. This reluctance was the most important drag on growth in 2012. But it is unlikely to prevail in 2013. The ECB’s willingness to act as a backstop for solvent euro zone sovereigns, and Angela Merkel’s decision that Greece should stay in the euro zone,  have removed the prospect of an uncontrolled breakup of the monetary union. Additionally, there is hope that the recession in the periphery might ease in 2013, and the prospects for Asia are good. Both bode well for German exports, while interest rates are poised to remain at all-time lows.

Forward looking indicators already reflect these fundamentals. The Ifo business climate has already risen two months in a row. In December, business expectation had their biggest jump in more than three years. The stock market also seems to bet on better times ahead. The Dax index is up 30 percent since the darkest hours of the euro crisis, in early June 2012. This is not a case for gloom and doom.

(This article was initially  published as a Reuters Breakingviews comment on 15  January 2013.)

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