UBS: Germany: Are we too pessimistic on 2017 growth?

We expect slower German growth in 2017

2016 has been the best year for German GDP growth since 2011 with growth of 1.8%, due to a favourable combination of low oil prices, a public spending boost and exceptionally low interest rates. Looking ahead, we think some moderation is in store for 2017, to around Germany's trend growth rate of 1.3%. This is because consumers face headwinds from higher inflation, weaker public spending growth and export growth is expected to remain moderate. So far, GDP growth is holding up well, however, and most public-sector institutions remain more optimistic for German (and thus Eurozone) growth and do not project a 2017 slowdown. Also, clients increasingly ask about upside risks to our forecast. So are we too pessimistic and where could we be wrong?

Can fiscal policy repeat the 2016 boost?

We can think of two reasons why domestic demand could remain more solid than inour forecast. First, public spending could turn out stronger than thought. For example, a renewed pick-up in refugee inflows to a similar extent than in 2015/16 (which is likely to be met with political resistance though) could induce continued spending increases. Also, the government could introduce even more tax cuts and spending increases ahead of the autumn 2017 elections than promised so far (around 0.3% of GDP). Westress that such a stimulus would have to be significant, though, in order to match last year's efforts.

Can household consumption withstand higher inflation?

Second, consumers may suffer less from higher oil prices than we assume. First of all, oil prices could fall back again. But even with higher oil prices, households could maintain their purchasing power if wages were to accelerate even more than we think or if households reduced their savings. With the household savings rate standing below its long-term average, we would be cautious to expect declines, but we could bewrong.

Or could the external environment provide an unexpected boost?Finally, export growth could revive more than we envisage, making the economy less dependent on domestic demand. One obvious catalyst could be much stronger growth in the US than we currently expect, probably combined with a weaker euro. Assuming that around 40% of a US fiscal growth impulse spills over to Germany, a substantial US stimulus alone could likely offset the headwinds to domestic demand.

Overall, risks may be to the upside but we remain cautious

Taken together, we believe a lot of things need to go right in order to avoid a growth deceleration this year. Thus, we prefer to remain cautiously optimistic. One should also not lose sight of the numerous downside risks this year, ranging from election uncertainty in a number of Eurozone countries to the EU-UK negotiations on leaving the European Union.

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