Dose of fiscal stimulus can lift Germany out of the doldrums
Loose monetary policy has not stopped the country’s industrial sector weakening
Last month, I bumped into a group of German investors on their way to Oktoberfest. In a lively discussion, one of their questions stuck with me. Will a trade truce between the US and China spark a recovery in German industry?
It is remarkable that the question even needs to be asked, given the sector has historically been a pillar of economic strength in Europe. But that has changed in the past two years — it is now one of the region’s weaker spots. And judging from recent surveys of European purchasing managers, weakness in Germany is spilling over into other parts of Europe, including Sweden and Switzerland.
The short answer for my Lederhosen-clad friends: a US-China trade truce will not make much difference, either to the German or overall European outlook. It will simply not be enough given the damage already inflicted. After two years of disrupting global supply chains, nothing short of rolling back tariffs and an end to further trade skirmishes would do. Unfortunately, recent “truces” are not easing anxieties in global industry.
Problems with German and broader European industry go beyond the US-China trade war. Let us look at the source of recent European export weakness. China and US imports from the euro area are considerable — so a full trade resolution would certainly help the region’s manufacturing sector. But exports to emerging markets, unaffected by the trade war, are also sizeable and have been rising in recent years.
The UK’s contribution to the euro area’s export decline is also significant and under-appreciated. For a long time, Brexit was viewed as a political uncertainty for Europe. The UK economy weathered the initial political storm reasonably well. But after three years of uncertainty, the data now indicate it is struggling and will continue to do so.
In the European Commission’s most recent regional survey, every part of the UK economy reported greater weakness than any sector of the eurozone economy. After years of general stability, it was easy to forget that the UK is one of Europe’s biggest and most integrated economies. This economic uncertainty matters.
Another drag is the region’s auto sector, which is caught up in a mix of cyclical, structural and regulatory tailwinds. Global auto sales growth has been running below zero for more than a year, a trend normally associated with recession, not a robust global household sector. This weakness must be a worry.
Clearly the slowing in emerging-market growth has played a role, with China’s auto sales trend notably weak in the past year. But fears of a structural decline in auto demand is gaining traction — including the phasing-out of diesel and the greater use of ride-sharing. Lacklustre sales trends at this point of the cycle suggests longer-term drags are a factor.
Regulatory changes are also crimping the European auto sector. In Sweden, the new “bonus malus” rule, which rewards buyers of cars with low carbon emissions, is hurting demand for larger autos. Germany’s 2030 emission targets are weighing on its transportation sector.
For the past two years, analysts and policymakers have tried to look through the weakness in German and broader European industry. In 2018, it was blamed on a bad flu season. Then changes in auto emissions regulations. More recently, it was the water levels of the Rhine, which had fallen so much that shipping was disrupted. Yet the weakness in Germany industry persists.
Fixing the weakness in German industry requires a new approach. The European Central Bank’s monetary ammunition is nearly spent — a message made clear by recent disagreement within the ECB on its latest stimulus package. Either way, German monetary policy has been loose for many years but this did not stop the weakening in its industrial sector. Currency weakness will provide a cushion. But with the US administration focused on the currency market, it is not clear this avenue can be explored any further.
The case for a more aggressive German fiscal policy is overwhelming. But why would Germany abandon years of austerity? Because it makes economic sense: Germany is experiencing a period of acute industry stress for the first time in nearly 20 years. It makes financial sense: real yields on 10-year German government bonds are at minus 1.5 per cent. And Germany has the capacity. Under current EU rules, Germany can take two percentage points off its fiscal surplus without raising any flags.
Still, my answer to the German investors was also guardedly optimistic. The weakness in German industry may be just the catalyst Europe needs to kick-start a more aggressive fiscal stimulus programme. This has already begun: 2019 will be the first year in 10 that fiscal policy has eased, including in Germany. So far, it has been modest, but plans for next year are more ambitious. A convincing programme of fiscal stimulus may deliver what Germany really wants — higher Bund yields.
The writer is global head of desk strategy at NatWest Markets