RWI is revising its economic cycle forecast upward, now expecting the German economy to grow by 3.7% this year, after a March forecast of 2.9%. In the meantime, domestic demand is driving growth more than demand from abroad. For 2012, RWI is expecting the GDP to increase at a less vigorous rate of 2.3% as a result of investment activities losing momentum. At the same time, foreign trade is expected to account for a smaller share of growth. The job market will probably continue to expand, albeit at a slower rate in the coming year. The situation of public budgets will probably also improve considerably during the forecast period. On the other hand, the repercussions of the financial crisis continue to represent a substantial risk for the business cycle in Germany.

The German economy continues to experience a vigorous upswing. During the first quarter the seasonally adjusted figure for real gross domestic product increased by 1.5% over the previous quarter, and indicators are suggesting an additional increase for the current quarter. While foreign demand continues to contribute to growth, domestic demand has come to play a more dominant role. Private consumption expenditures increased at a constant, but not especially high, rate. Investments, both in equipment and buildings, were the major drivers of economic expansion. Building investments in particular benefit from the unusually low real interest rates, a consequence of the ECB’s expansionary monetary policy as well as of the reputation of German capital market securities, which foreign investors regard as a safe haven.

Early indicators would suggest that growth will come to a halt during the second half of the year. The volume of orders received continued to increase at a noticeable rate until most recently, and the mood among businesses is still very optimistic when compared over the long term, even though recent surveys reveal a slight downturn. The increases will probably be smaller than in the first quarter, however. This has already become evident considering that the first quarter benefited from several special factors, among them renewed building activity, which began (in a manner untypical for the season) in February and March and partially made up for the loss in construction production that had resulted from the early onset of winter in December 2010. Another factor was the Easter holidays, which came exceptionally late this year and consequently did not have an effect on economic activities during the first quarter.

In addition, the global economy has in the meantime lost momentum. Japan’s short-term production losses in the wake of the earthquake have probably played a certain role in this development. Beyond this, a number of emerging countries have in the meantime recognized the threat of an overheating economy and responded with a more restrictive economic policy. Considering these developments, foreign demand is expected to grow at a slower rate than previously seen. Domestic demand, in contrast, is expected to grow at a strong and stable rate, and will probably continue to be stimulated by real capital market interest rates, which are expected to have an expansionary effect in Germany, despite any further cautious interest rate hikes by the ECB. The proportion of disposable income will probably also grow at an accelerated rate, spurred by expected further growth in employment, a sharper rise in actual earnings and an improved profit situation. Based on this scenario, the upward trend in private consumption expenditures is likely to persist, while investment activity will also continue at an elevated level, even if the growth rates seen recently cannot be maintained. In sum, we expect real GDP to grow by 3.7% in 2011.

Labor shortages fuel wage and salary increases

Considering the rising production levels, a continued rise in employment levels is expected. The number of persons in employment is predicted to grow by an average of 1.2% for the year as a whole. On the other hand, a shortage of skilled employees is becoming evident within certain sectors of the labor market. This development probably accounts for the accelerated rise in wages and salaries, which is being seen more for actual earnings than for wages based on collective agreements, suggesting that companies are increasingly paying wage supplements. Yet the wage and salary levels regulated by collective agreement are also likely to see a strong hike in the coming year. Unit labor costs will consequently rise at an accelerated rate. These developments lead us to expect, on the one hand, a higher domestic inflation rate as well as retarded growth in employment. Growth in domestic demand is likely to slow down in consequence. In addition, exports will probably contribute less to economic growth, since foreign demand is expected to increase at a slower rate and Germany’s ability to compete with international price levels will deteriorate somewhat. According to our estimates, real GDP growth will slow down to 2.3% in the coming year.

Inflation, while expected to rise to a level of 2.4% this year, will probably level off slightly to 2.3% in 2012. Whereas inflation this year will probably largely result from increasing import prices, domestic inflation will be the major contributing factor next year. This is based on the assumption that the level of commodity prices remains unaltered compared with previously observed levels. With core inflation continuing to rise during the forecast period, there is an imminent risk of inflation pressure building up, which could prove a threat to medium-term price stability.

Economic upswing brings additional revenues to public budgets

The situation of public budgets is likely to improve considerably during the forecast period. A substantial volume of additional revenues can be expected on account of the economic upswing and of rising inflation, while expenditures for social benefits will probably decrease in the wake of economic growth. Public debt is consequently expected to decline to a level of 1.3% relative to the GDP this year and, further, to 0.2% next year, which would represent an almost balanced budget.

Thus, the German economy continues to show unexpected strong growth, and we are once more revising the forecast for 2011 upward. A major factor in this development is the low level of real interest rates; since introduction of the euro, rates have not remained for any extended period at a level comparable to that recorded in the past eighteen months. However, considerable risks are still threatening. The repercussions of the financial crisis are far from having been absorbed. The eurozone continues to be troubled by the high level of debt among many member countries, while government debt in the United States has also reached a dangerous level. An additional threat is the supply of liquidity, which the central banks had broadly expanded in response to the financial crisis but have not yet reduced to any substantial degree. There is consequently a significant danger of renewed excesses and of rising inflation levels worldwide.

For further information, please contact:
Prof. Dr. Roland Döhrn, Tel.: +49 201 81 49-262, e-mail
Sabine Weiler (Press office), Tel.: +49 201 81 49-213, e-mail

Key figures of the forecast of June 2011
Changes in relation to previous year in %

Own calculations according to information from the Federal Statistics Office, the Federal Bank of Germany and the Federal Labor Agency. - ¹Adjusted for price changes. -²Including non-profit private organizations. -  ³Domestic figuers. - ⁴National differentiation. - ⁵In differentiation of the Federal Labor Agency. - ⁶Consumer price index. - ⁷Remuneration per employee in relation to real GDP per employed person. - ⁸In differentiation of the national income accounting. -⁹In differentiation of the balance of payment. - ^SOwn Estimate.