KfW Business Cycle Compass: Growth is back, but the upward trend is not endless

• The service sector is the driver; supply bottlenecks hold back industrial production
• KfW Research lowers its forecast for economic growth to 3.0% for 2021 (previous forecast: 3.5%); GDP expected to increase by 4.2% (4.0%) in 2022
• Eurozone growth 4.7% (4.5%) in 2021 and 4.3% (unchanged) in 2022

Thanks to the, at times, marked fall in the number of COVID-19 infections, the German economy recovered in the second quarter of 2021 and gross domestic product rose by 1.6%. In the current third quarter, KfW Research is expecting robust growth, with the service sector continuing to provide the main impetus. At the same time, persistent supply bottlenecks in manufacturing industry are a hindrance. For 2021 as a whole, KfW Research has therefore revised its economic growth forecast downwards and now expects GDP to grow by 3.0% (previous forecast 3.5%, all rates price-adjusted). Apart from growth-inhibiting materials shortages, the downward correction is partly due to the routine data revisions undertaken by the Federal Statistical Office, which has now calculated a drop of - 2.0% in GDP for the first quarter of 2021, in contrast to the originally published figure of -1.8%. It has also revised the figures for several quarters in the previous year. KfW Research is somewhat more optimistic than it was about the coming year and now expects economic output to increase by 4.2% (4.0%).

“Growth is back, but the upward trend is not endless,” sums up Dr Fritzi Köhler-Geib, Chief Economist at KfW. “Powerful growth impulses are coming from the service sector, which got off to a lively start to the summer quarter. On the other hand, manufacturing industry is not expected to make a significant contribution to growth before the end of the year. Until then, the shortage of supplies of materials and inputs will dampen industrial production in particular, but also the construction sector.”

The current bottlenecks are affecting many products. The shortage of semiconductors is particularly serious, which is why manufacturers of electrical equipment, motor vehicles and automotive parts are hardest hit. Even if the shortages prove more persistent than originally anticipated, they are nevertheless only a temporary inhibiting factor for growth. The backlog of orders is likely to be cleared one step at a time. As a result, manufacturing industry is expected to be the main reason for quarterly growth rates lying well above the long-term average next year. There is also a considerable statistical overhang from the current year, with the result that we can expect growth of 4.2% in 2022. Taking GDP in the fourth quarter of 2019 as the yardstick, the German economy will move slightly ahead of the pre-crisis level in autumn this year.

The declining rate of vaccinations and the spread of the Delta variant, which has been responsible for the sharp and continuing increase in the number of infections since July, are giving cause for concern about German economic growth. The pressure of infections is also likely to rise after the end of the school holidays and as a result of seasonal effects in autumn. However, across the board closures in the retail and hospitality sectors appear unlikely at the moment in view of the possibilities for keeping infection risks in check with face coverings, tests and, above, all vaccinations. The fact that some countries, for example the Netherlands and Spain, have broken the first Delta wave with only minor restrictions is also cause for hope.

In the euro area, the economy grew somewhat more quickly in the second quarter than in Germany. The main engines of growth were the southern European countries, where containment measures were relaxed a little earlier and supply bottlenecks in industry play a subordinate role. In the remainder of the year, the quarterly profiles of most euro countries are expected to be similar to Germany’s, as the joint procurement of vaccines and the ECB’s very expansionary monetary policy have created similar conditions for beating the coronavirus crisis. KfW Research expects the euro area to grow by 4.7% this year, and in 2022 the economy is projected to expand by 4.3% (previous forecasts: 4.5% and an unchanged 4.3%).

The current KfW Business Cycle Compass is available at: www.kfw.de/konjunkturkompass