ifo Economic Forecast Autumn 2022: Inflation Stifles Private Consumption - German Economy Facing a Hard Winter
The German economy is cooling sharply. High inflation rates are eroding the real incomes of private households and their savings, reducing their purchasing power. Gross domestic product will increase by 1.6 percent this year and then contract by 0.3 percent next year. Inflation will average 8.1 percent this year and rise to 9.3 percent next year. It is expected to peak in the first quarter of 2023 at around 11 percent. In 2024 the economy will gradually return to normal. Economic output is expected to increase by 1.8 percent and inflation to fall to 2.4 percent.
Situation of the German Economy
After a strong start to the year, the German economy has been cooling since the summer. High inflation rates are eroding the real incomes of private households and their savings, reducing their purchasing power. Many consumer-related service sectors were still able to benefit from the end of the Omicron wave and expanded their sales strongly into May. However, having already left its mark on the retail sector since the spring, the reluctance of consumers to spend also became increasingly noticeable here. In line with this, the business climate in consumer-related areas has recently deteriorated significantly.
Manufacturing also suffered a setback in the summer. On the one hand, production is being hampered by continuing supply problems with raw materials and intermediate products. On the other, demand is suffering from high prices and the global economic slowdown. However, the decline in orders is unlikely to have led to a significant drop in production, as companies’ order books are still well above average. This is probably one reason why the business climate in manufacturing and manufacturing-related service sectors has deteriorated only slightly in recent months. By contrast, there are signs of a significant downturn in construction activity. In addition to high construction costs, this is likely due mainly to the interest rate turnaround, which is also pushing up financing costs. A sharp rise in order cancellations and a decline in new orders have caused the business climate in construction to fall as sharply since March as it last did during the global financial crisis in 2008.
Forecast for the German Economy
Overall, the economic slowdown will continue. While economic output is still expected to stagnate in the third quarter of 2022, it is likely to contract by 0.2 percent and 0.4 percent respectively in the two quarters of the winter half-year. The key factor here is likely to be a decline in private consumer spending. As energy suppliers will be markedly adjusting their electricity and gas prices in the light of high procurement costs, especially at the beginning of 2023, the inflation rate is expected to peak at around 11 percent in the first quarter of 2023. This will result in a sharp drop in real household incomes and a noticeable decline in purchasing power. Although the measures taken by the German government under Relief Package III are expected to counteract this decline somewhat, they will fall far short of offsetting it. Price increases will gradually weaken over the rest of the coming year. It is assumed that gas will be available in sufficient quantities in the winter. Energy prices should therefore stop rising and should start falling again from spring 2023 at the latest. The core inflation rate is likely to remain high for the time being, partly because the rise in wage payments will gradually accelerate as new collective wage agreements are concluded. At the same time, however, real household incomes are expected to rise again from mid-2023, which will stimulate consumer spending.
“The cuts in gas supplies from Russia over the summer and the drastic price increases they triggered are wreaking havoc on the economic recovery following the coronavirus. We don’t expect a return to normal until 2024, with 1.8 percent growth and 2.4 percent inflation.”
Manufacturing will gradually work off the high order backlogs in the coming quarters, slowly expanding its output. The assumption is that supply bottlenecks will continue to be a hindrance, but will gradually ease as the global economy cools. It is also assumed that there will be no gas shortages during the winter, which would be followed by a rationing of gas supplies to manufacturing companies. Consequently, manufacturing and the associated business service providers will support the economy in the forecast period. By contrast, construction, which is likely to suffer most directly from rapidly rising financing costs, will act as a brake. In this forecast, key interest rates are expected to rise to 4 percent by the end of next year.
Key Forecast Figures for Germany
| 2021 | 2022 | 2023 | 2024 | |
| Gross domestic product (percentage change over previous year) |
2,6 |
1.6 | -0,3 | 1,8 |
| Employment (1,000 persons) | 44.980 | 45.534 | 45.634 | 45.710 |
| Unemployment (1,000 persons) | 2.613 | 2.417 | 2.470 | 2.358 |
| Unemployment rate (in % of civilian labor force) | 5.7 | 5.3 | 5.4 | 5.1 |
| Consumer prices (percentage change over previous year) | 3.1 | 8.1 | 9.3 | 2.4 |
| Unit labor costs (percentage change over previous year) | 0.7 | 3.3 | 6.2 | 4.0 |
| Unit labor costs (percentage change over previous year) | 2021 | 2022 | 2023 | 2024 |
| in Mrd. EUR | -134.3 | -71.2 | -48.0 | -64.6 |
| in % of GDP | -3.7 | -1.8 | -1.2 | -1.5 |
| Balance on current account | 2021 | 2022 | 2023 | 2024 |
| - in Mrd. EUR | 265.0 | 181.0 | 240.9 | 270.0 |
| in % of GDP | 7,4 | 4,7 | 5,9 | 6,3 |
Source: Federal Statistical Office; Federal Employment Agency; Deutsche Bundesbank; 2022 to 2023: forecast by the ifo Institute.
© ifo Institute Sept. 2022
All in all, real GDP will increase by 1.6 percent this year and contract by 0.3 percent next year. Inflation will average 8.1 percent this year and rise to 9.3 percent next year. Compared with the ifo Economic Forecast Summer 2022, the growth forecast for the coming year in particular has thus been significantly lowered by 4.0 percentage points and the inflation forecast raised sharply by 6.0 percentage points. In the wake of the economic slowdown, the increase in employment will slow temporarily. However, the rise in unemployment by a good 50,000 in the coming year is due mainly to the surge in the number of unemployed Ukrainian citizens in the summer of 2022, who will only gradually be integrated into the labor market over the forecast period. In 2024, the economy will gradually return to normal. Economic output is expected to increase by 1.8 percent, inflation is expected to fall to 2.4 percent, and unemployment is expected to decline again. The government budget will remain in deficit this year and in the next two years, averaging 1.5 percent of economic output. The relief packages, rising interest expenditure, and the economic slowdown are postponing the previously expected consolidation of public finances.
Risks to the Forecast
The risks to this forecast are manifold. First and foremost, the assumptions made about the further development of energy prices and how energy suppliers will pass them on to consumers could turn out to be wrong. As a result, the loss of purchasing power for households could be more or less significant and consumer spending could take a different course.
The form in which the state intervenes in the price situation also plays a role here. For example, the forecast does not yet take into account the electricity price cap envisaged in Relief Package III and the subsidization of electricity grid fees, as the specific form of the measures was too imprecise at the time the forecast was prepared. This should mitigate the price increase and thus support the economy. However, energy prices could also rise further if gas supplies become too tight in winter after all. In addition to higher losses in purchasing power and a greater reduction in consumption, there would probably also be production declines in manufacturing if gas had to be rationed.
It is also unclear how private households will react to the high price rises and the associated liquidity squeeze. In this forecast, it was assumed that they will temporarily raise their disposable household income by reducing their propensity to save. This can be achieved, for example, by setting aside a smaller amount from monthly income, liquidating existing financial assets, or taking on more new debt. It was assumed that the savings rate would fall to 8 percent in the first half of 2023, well below the average of around 10.5 percent in the years before the coronavirus crisis. Calculated for 2023 as a whole, this will generate additional purchasing power of just under EUR 40 billion, noticeably mitigating the real economic impact of the price shock in the forecast. However, such a decline in the propensity to save cannot be derived directly from experience with the consequences of the two oil price crises in the 1970s and 1980s. Rather, in those times of high inflation, households put aside an increasing share of their income, possibly as a precautionary measure. Although uncertainty is also high today, a decline in the propensity to save does not seem implausible for other reasons. For example, the loss of purchasing power, measured by the decline in real per capita wages this year and next (by around 3 percent each), is higher than at any time since the current system of national accounts was introduced in 1970. The same applies to the devaluation of savings, which, measured by the short-term real interest rate, is at a record low of around −6 percent on average this year and next.
Finally, there are also risks with regard to assumptions concerning supply chain issues and the further course of the coronavirus pandemic. It cannot be ruled out, for example, that infection rates will accelerate again from the fall onward and that more dangerous virus variants will emerge, resulting in renewed restrictions on public life and thus placing an additional burden on the consumer economy. This could also once again disrupt global supply chains and production in Germany.
