German Economy Shows Signs of Recovery, But Consumer Confidence Remains Low

Germany's economic outlook has improved slightly since the last quarter, but challenges remain, according to a new report by Moody's Analytics. While the country's real GDP expanded by 0.2% in the first quarter, driven largely by favorable weather conditions in the construction sector, the recovery remains fragile and dependent on external factors.

Consumer confidence, a key driver of economic growth, remains low, leading to a 0.4% decline in consumption in the first quarter. Households are holding back on spending, opting to save on a precautionary basis due to ongoing economic uncertainty.

"The GfK consumer climate survey reports that consumers' propensity to save has increased considerably in May, denting the likelihood of a rapid rebound in spending," the report notes.

The German labor market is also showing signs of strain. While firms are reluctant to lay off skilled workers due to persistent skills shortages, employment growth is slowing, and the unemployment rate has climbed to 5.9%. This highlights a divergence in economic prospects across sectors, with service-sector firms more inclined to hire than those in goods-producing industries.

"Employers in goods-producing industries are choosing to reduce vacancies and put workers on the Kurzarbeit short-time work scheme that provides a government subsidy for hours not worked," explains Moody's Analytics.

However, this approach may not be sustainable in the long term. If the economic lull persists, employers may begin shedding staff at a faster rate than anticipated.

The report also highlights a mixed picture in specific sectors. While the outlook for energy-intensive industries is improving, with high-frequency data on industrial energy usage suggesting a gradual recovery, the real estate market continues to face headwinds.

"With the cuts expected in 2024, it's difficult to see how residential and commercial real estate demand can be further facilitated," says the research firm.

The sharp and protracted drop in prices, coupled with tight monetary policy, makes housing and commercial real estate finance particularly vulnerable.

The report concludes that a number of downside risks dominate the German economic outlook. These include:

• The potential for a sharper-than-expected impact from already tight monetary policy combined with less-supportive fiscal policy.
• The lagged, nonlinear effects of high rates could affect pockets of the economy and then spread, engulfing more sectors.
• Housing and commercial real estate finance seem particularly vulnerable at the moment given the sharp and protracted drop in prices, but other parts of the financial system may also come under strain with some financial turbulence.
• Any unforeseen shock could cause the recent gains in household and business confidence to reverse, spelling trouble for already-troubled domestic demand.

"German assets are usually seen as a safe haven in times of financial distress, potentially muting the impact of any turbulence ahead," the report concludes.