ifo Economic Forecast

ifo Economic Forecast Summer 2022: Inflation, Supply Bottlenecks, and War Slow Economic Recovery in Germany

Since the beginning of the year, the German economy has been recovering from earlier waves of the coronavirus. The associated normalization of spending in the consumer-related service sectors is giving the economy a strong boost. However, high inflation, the war in Ukraine, and continuing supply bottlenecks are slowing the economic recovery in almost all sectors of the economy. GDP will grow by 2.5 percent in 2022 and 3.7 percent in 2023. This year the inflation rate is expected to reach 6.8 percent, its highest level since 1974. Consumer prices are also expected to rise at an above-average rate of 3.3 percent next year.

German Economy Came through the Coronavirus Winter Well

The German economy came through the two coronavirus waves in the past winter half-year well. After a slight decline of 0.3 percent in the final quarter of 2021, economic output was already up again in the first quarter of 2022 and was most recently still just under 1 percent below its pre-crisis level at the end of 2019. The economic recovery thus took a temporary pause. Economic activity in contact-intensive services started picking back up from January onward and made a significant contribution to the 0.2 percent rise in overall economic output in the first quarter. The construction industry also enjoyed a strong start to the year, benefiting from full order books and a mild winter. 

By contrast, economic output in manufacturing stagnated in the first quarter. The initial effects of the war in Ukraine were already being felt here. For example, exports to Russia slumped in March as a result of sanctions. Taken individually, this reduced Germany’s overall exports of goods by 1.2 percent within one month. In addition, the war exacerbated the bottlenecks in the supply of raw materials and intermediate products from which manufacturing has already been suffering since last year. The automotive industry in particular therefore had to temporarily curb production in March. Ultimately, the bottlenecks and the sharp rise in energy prices pushed up production costs and thus producer prices significantly. As a result, orders received by manufacturing companies have decreased since the beginning of the year.

Consumer spending is also showing early signs of the high inflation rates. The increase in consumer prices reached 7.9 percent in May. In addition to energy, food prices in particular have risen significantly in recent months. However, the prices of other goods and services also increased at well above average rates. The associated loss of purchasing power by private households was reflected in declining goods consumption at the beginning of the year. However, thanks to a noticeable increase in spending on services, overall private consumption stagnated in the first quarter. This reflected the waning of the coronavirus wave and the associated normalization of household spending patterns. 

“Economic output is currently still 1 percent below the pre-pandemic level of late 2019, but we are expecting a gradual decrease in both commodity prices and material bottlenecks in the second half of the year.”

Prof. Dr. Timo Wollmershäuser, Deputy Director of the ifo Center for Macroeconomics and Surveys and Head of Forecasts

Outlook Weighed Down by Inflation, Supply Bottlenecks, and War

In the coming months, the economy is likely to continue to be determined by two very different forces. Supply-side disruptions continue to weigh on output, while at the same time keeping prices high. Supply bottlenecks in particular are likely to persist in the coming months, holding back both manufacturing and construction activity. In particular, the lockdowns in China, which have paralyzed production and shipping in some regions since March, will probably have a delayed impact in Germany. High commodity prices are also likely to fall only slowly, as an end to the war in Ukraine is unlikely in the near future. Accordingly, sentiment in manufacturing and construction has deteriorated noticeably compared with the start of the year. As a result, value added in these two sectors is likely to shrink in the second quarter.

However, these negative factors are likely to become less significant as the forecast progresses. This forecast assumes that supply bottlenecks will gradually ease in the second half of the year and that raw material prices will fall. Although order intake is now declining as a result of high prices, the order books of manufacturing and construction companies are still full to bursting, with a recent backlog of around 4.5 months. This should result in a reduction in the order backlog in the second half of the year, giving a strong boost to production in the manufacturing sector.

Post-Pandemic Normalization of Consumption Driving the Economy

The economy is being stimulated by the further normalization of private households’ saving and spending behavior. Particularly in the area of contact-intensive services, there is still considerable catching up to do compared with spending behavior before the outbreak of the coronavirus crisis. As a result, private consumer spending is expected to expand at above-average rates in the current and coming quarters and be the main economic driver this year, with a price-adjusted increase of 4.8 percent. 

The high inflation rate, which at 6.8 percent this year is likely to be the highest since 1974, is in itself holding back the recovery in private consumer spending. This is probably the main reason why sentiment in the retail sector has deteriorated recently. Neither the rise in net wages nor the increase in government transfer payments is likely to offset the loss of purchasing power due to sharply rising prices. It is true that the government’s two relief packages have reduced taxes and increased transfers, and the increases in the minimum wage are also boosting wage incomes. Taken together, however, disposable incomes will increase by 6.2 percent this year, which is less than consumer prices. This already takes into account the price-reducing measures of the relief packages (abolition of the EEG levy, nine-euro ticket for public transport, temporary reduction in fuel tax), which will lower the inflation rate by around 0.5 percentage points this year.

Employment Growth Slows

The labor market is expected to continue its recovery from the coronavirus crisis. However, momentum will slow noticeably due to the war in Ukraine, supply bottlenecks for key inputs and intermediate products, and the worsening shortage of skilled workers. The number of people in work is expected to increase by around 626,000 in 2022 and by 190,000 in 2023. Registered unemployment is expected to be around 302,000 lower this year than a year earlier, before falling by a further 24,000 next year. As a result, the unemployment rate will fall from 5.7 percent last year to 5.0 percent on average in 2022 and 2023.

Fiscal Policy Neutral

Fiscal policy this year is dominated by the extensive relief packages. However, this is offset by the discontinuation of coronavirus-related spending and support measures, so that overall fiscal policy is neutral. In 2023, the fiscal impulse is then likely to become slightly restrictive with the discontinuation of many measures. The government financing deficit will halve this year compared with the previous year to around EUR 65 billion. This trend will continue in 2023, when the deficit will be just under EUR 12 billion. Government gross debt will fall to 62.6 percent in 2023 due to lower deficits and noticeable growth in nominal GDP.

Economy Grows by 2.5 Percent

Taken together, overall economic output in the second quarter of the current year is likely to increase by 0.4 percent quarter over quarter. In the second half of 2022, the German economy is then expected to recover at stronger rates of 1.2 percent and 1.4 percent before slowly shifting to average growth rates. All in all, GDP will grow by 2.5 percent this year and by 3.7 percent next year. These growth rates are within the range of the ifo Spring 2022 economic forecast, in which two scenarios were calculated due to the high level of uncertainty about the impact of the war in Ukraine.
 

Key Forecast Figures for Germany

  2020 2021 2022 2023
Gross domestic product (percentage change over previous year)   -4.6 2.9 2.5 3.7
Employment (1,000 persons) 44898 44918 45544 45734
Unemployment (1,000 persons) 2695 2613 2311 2288
Unemployment rate (in % of civilian labor force) 5.9 5.7 5.0 5.0
Consumer prices (percentage change over previous year) 0.5 3.1 6.8 3.3
General government financial balance 2020 2021 2022 2023
 - EUR billion -145.2 -130.8 -64.8 -11.9
  - in % of GDP -4.3 -3.7 -1.7 -0.3
Balance on current account 2020 2021 2022 2023
 - EUR billion 238.7 265.2 181.1 241.2
  - in % of GDP 7.1 7.4 4.8 5.9

Source: Federal Statistical Office; Federal Employment Agency; Deutsche Bundesbank; 2022 to 2023: forecast by the ifo Institute.
© ifo Institute June 2022

Infographic, Gross Domestict product in Germany, ifo Economic Forecast summer 2022

Global Economy: Under the Sign of War and Inflation

While consumer confidence in the euro area has plummeted since the outbreak of war in Ukraine, sentiment in the service sector has remained persistently optimistic. The momentum there is largely driven by recovery effects following the pandemic-related closures and is proving to be a pillar of economic activity. Goods manufacturing, on the other hand, is increasingly suffering from glaring price increases and ongoing supply chain difficulties. Production expectations already fell abruptly in March 2022, apparently – in a similar way to consumer confidence – as a direct result of the outbreak of war in Eastern Europe. In May 2022, however, manufacturing companies’ assessments of the current situation also weakened noticeably for the first time; a temporary weakening of industrial activity is therefore likely. Overall, euro-area GDP is expected to grow by 3.3 percent in 2022 and by 2.8 percent in 2023.

Provided the oil embargo imposed by the EU on Russia does not lead to a renewed acceleration in inflation, inflation in the euro area will have peaked in the second quarter of 2022 and will gradually weaken over the forecast period. However, the delayed transmission of commodity prices to retail prices and the compensation of real wage losses through high wage settlements will ensure that inflation in 2023 will be higher than in previous years. The overall inflation rate is expected to be 6.1 percent for the current year and 2.6 percent for the coming year. Accelerating inflation will prompt the ECB to tighten monetary policy in the euro area more quickly. After bond purchases under the Pandemic Emergency Purchase Programme were discontinued in March 2022, those under the long-standing Asset Purchase Programme will also end in June. Key interest rates will then be raised as early as the summer, and further interest rate increases are likely to follow in the fall.

In the United States, the domestic economy is still proving robust and the labor market is tightening more and more, resulting in strong wage growth. Accordingly, a wider range of goods and services is affected by sharp price increases than in the euro area, while commodity price increases are playing a less prominent role. Adverse supply shocks are less of an inflation driver in the US than in the euro area. Accordingly, the Federal Reserve is tightening monetary policy more rapidly than the ECB. After its first rate hike in two years in March 2022, by 25 basis points, it increased its key interest rate by another 50 basis points in May 2022. A few more interest rate increases will follow over the forecast period. These will dampen economic activity and overall economic growth, to 2.4 percent this year and 2.0 percent next year.

In China, rigid lockdowns and traffic restrictions, particularly in Shanghai, have recently had a severe impact on the economy. It will take some time for things to return to normal; in view of developments over the past two years, tangible consequences for global trade in goods and the world economy can also be expected in the longer term. Nevertheless, the Chinese government continues to pursue a zero-Covid policy, albeit with exceptions for quarantined areas to shorten the time before restrictions are lifted. However, government spending, especially on infrastructure projects, is likely to shore up the economy. In contrast to most advanced economies, monetary policy in China is tending to loosen after being tightened in the previous year in the wake of the real estate boom. Overall, gross domestic product is expected to grow by 3.8 percent this year and by 5.3 percent in the coming year.

The Japanese economy is recovering from the pandemic-related setback at the beginning of the year, but the lockdowns in China are weighing on export demand and exacerbating supply chain problems. After the Omicron wave subsided and restrictions were lifted in mid-March 2022, private consumption accelerated, but households’ real income losses due to inflation are slowing the recovery. The Bank of Japan is likely to maintain its zero interest rate policy.

Overall, the world’s gross domestic product is expected to grow by 2.9 percent this year and by 2.8 percent in the coming year. Global trade should rise by 2.8 percent in 2022 and by 3.9 percent in 2023.

Infographic, gross domestic product in the world, ifo economic forecast summer 2022

Risiks

  • Pandemic
  • Effects of the Ukraine war / Russia sanctions
  • Inflation trend
  • Supply bottlenecks for intermediate products and raw materials
Contact
Prof. Dr. Timo Wollmershäuser

Prof. Dr. Timo Wollmershäuser

Deputy Director of the ifo Center for Macroeconomics and Surveys and Head of Forecasts
Tel
+49(0)89/9224-1406
Fax
+49(0)89/907795-1406
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