Worries Mount About Germany

July 7, 2008

Corporate prosperity in Germany was major reason for above-trend growth in Euroland in recent years.  More broadly, trends in the euro area and in its largest member economy tend to move in tandem, so policymakers are forced to watch Germany even as they keep their eye on the whole area’s performance.  President Trichet has instructed analysts to consider the first half of 2008 as a whole and not to dwell unduly on weakness in the second quarter which followed growth of 6.1% saar during the first quarter.  That’s a sensible approach.  But a forward-looking indicator, industrial orders, have recorded six straight monthly drops of 1.2% in December, 0.7% in January, 0.6% in February, 0.5% in March, 1.7% in April and 0.9% in May.  The decline between November and May was 10.7% at a seasonally adjusted and annualized rate, with domestic demand for capital goods down 10.1% saar and foreign orders for capital goods plunging by 28.5% saar.  Industrial production in April-May was 1.9% below the first-quarter level, reversing a 1.7% 1Q-over-4Q07 advance.  The German PMI scores in June remained above the 50 line of demarcation between expansion and contraction;  however, each was revised downward last week.  From May, that for manufacturing fell 1.0 points to 52.6, and the gauge for services dropped by 1.7 points to 52.1.  The German labor market is still performing decently, with unemployment falling 38K last month, over three times forecast, and jobs showing an on-year increase of 1.6%.  Usually, but not this time, a good labor market promotes consumer spending.  The average volume of retail sales in April-May was 2.2% less than its first-quarter level including the automotive sector and spending at gas stations.  German export and import data will be released Wednesday at 06:00 GMT.  Weakening foreign orders suggest some deterioration in what has been a very strong sector.

German officials have not joined the chorus of politicians who’ve been critical of the ECB’s rate hike in the face of slowing growth.  The main economic problem for Germany has not been euro appreciation but rather accelerating domestic and imported inflation. Consumer price inflation of 3.3% in June was the highest since December 1993, when the economy was hung over from the stimulus of the unification of West Germany and East Germany.  Hyperinflation in the 1920’s was a key seed of the political horror that befell Germany in the 1930’s and 1940’s.  Because of that perceived cause-and-effect connection, internal and external price stability took on the sacred symbolism that  countries tend to bestow on their national flag.  The ECB’s single mandate of price stability is a hand-me-down from the German Bundesbank.  Weaker growth may keep the ECB from following up on last week’s rate hike anytime soon, but it will be a long time before the Fed raises rates without the ECB also tightening, and I can imagine circumstances ahead in which the Fed eases but the ECB does not.



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