Macro outlook 2023: Germany’s softening headwinds should not mask a difficult year ahead for corporate balance sheets
The upbeat macroeconomic sentiment at the turn of the New Year is unmistakable throughout the euro area, led by an improved outlook in Germany, the bloc’s largest economy. Europe’s mild winter helped ease energy consumption led to a sharp fall in wholesale natural gas prices, while German fiscal support aided businesses and households. New Year optimism is underpinned by receding inflation expectations and the reopening of China’s economy, which would provide a material boost for German exports.
However, the European Central Bank (ECB) is far from declaring victory on inflation. “Inflation by all accounts… is way too high,” ECB president Christine Lagarde told a panel at the World Economic Forum in Davos on 19 January. “We shall stay the course.” Tighter financial conditions have implications for corporate debt serviceability and refinancing requirements as debt costs rebase higher for longer. Broad-based price pressures are still rising in the euro area, while tighter financial conditions will weigh on economic activity and corporate balance sheets.
Euro area annual inflation was 8.5% in January, down from 9.2% in December, according to Eurostat’s first estimate, as energy inflation moderated. Headline inflation in the euro area is projected to decelerate from 8.4% in 2022 to 5.6% in 2023 and to 2.5% in 2024. Eurozone GDP slowed to 0.1% in Q4, its weakest growth since Q1 2021. Euro area GDP is forecast to increase by 0.9% this year, according to the European Commission’s Winter interim forecast, compared with an earlier forecast of a 0.1% contraction. However, some forecasters anticipate a recession in the first half of 2023.
Corporates and investors have yet to absorb the diminished market liquidity from tighter financial conditions and the unwinding of the ECB’s outsized €8.8 trillion balance sheet. Starting in March, the ECB plans to reduce its holdings in its asset purchase program (APP) by not reinvesting all of the principal payments from maturing securities at a pace of €15 billion per month until the end of the second quarter. The impact of this liquidity reset will take time to see, but further the regime shift away from accommodative monetary policy.
In this second article exploring the macro environment in select markets across Europe, we examine the outlook for Germany, Austria, and Poland.
The German economy was described as “gratifyingly resilient” in 2022 by the economy ministry, attributed to the catch-up effects after the pandemic, improved private consumption and waning supply bottlenecks. Germany is now forecast to avoid a recession in 2023, with EU Commission projecting a small increase of 0.2% in GDP, a significant upward revision from the drop of 0.6% last November.
German economic activity contracted by 0.2% in Q4, according to Federal Statistical Office data, attributed to the lifting of pandemic lockdowns offset the economic costs from Russia’s war in Ukraine. Ruth Brand, head of the statistical agency, said the economy performed well despite “serious material shortages and delivery bottlenecks” and “massively rising prices”, including food prices, which rose 13.4% in 2022, and skilled labour wages. Germany has the third-lowest unemployment rate in the EU-27 at 3.0%.
Annual German inflation softened in the first months of the year, with consumer prices rising by 9.2% year on year in January in harmonised terms, according to the Federal Statistical Office, as the rise in energy prices significantly slowed. Non-harmonised annual inflation nudged up 10 basis points to 8.7% in January, while annual consumer prices rose 7.9% for 2022.
Germany’s wholesale gas and electricity prices fell markedly at the end of last year. It supported the slowdown in the annual rate of producer price growth to 21.6% in December, down from 45.8% three months prior and the lowest level since November 2021, the statistics office data showed. Continued moderation in energy prices in January and February should support another significant fall in German producer prices, translating into a shallower industrial downturn in energy-intensive sectors than was expected just two months ago. However, a less shallow downturn is not a significant pivot. Downward pressure on Germany’s services economy eased in January, according to the S&P Global’s German PMI index, as inflation pressures continue to lose momentum led by cooling of manufacturing cost pressures as supply chain strains eased. While businesses showed renewed optimism for the 2023 outlook and continued resilience in the labour market, multiple demand headwinds remained. High inflation and tightened financial conditions created investment reticence and inventory reduction among manufacturers, contributing to further broad-based fall in new work inflows.
As Europe grapples with intense macro and geopolitical problems, underlying price pressures are still rising, eroding purchasing power and softening consumer spending. All of which will keep a lid on the growth this year. The IMF described China’s pivot from “Covid Zero” policy as the most critical factor for global growth in 2023. However, the strength of China’s reopening presents a double-edged sword. If China’s reopening is weaker-than-expected, which may result due to softer discretionary spending, given the economy’s sluggish consumer confidence, tight job market, weakening exports and the impact of the ongoing property market correction, the boost to global growth – and the German economy – will be diminished. On the other hand, if a strong China reopening materialises, it will introduce renewed inflationary pressures in the global economy. For example, as Chinese demand for liquefied natural gas (LNG) picks up, it will divert supplies away from Europe, which may act as a further energy inflation catalyst when the EU is highly committed to diversifying away from Russian energy. Thus, currently, the downsides of either scenario for global growth, and the German economy, may be somewhat overlooked.
Annual CPI inflation in Austria increased in January to 11.1%, according to Statistics Austria data, reversing three months of deceleration. The inflation upswing was attributed to strong price increases for household energy, despite the electricity price cap which are not expected to take effect until March. Consumer prices rose by 0.8% in January. Elsewhere, housing and water costs remain high. Average annual inflation rate of consumer prices in 2022 soared three-fold higher year-on-year to 8.6 %, according to Statistics Austria, in the highest inflation level since the 1974 oil price crises. The harmonised inflation rate was also 8.6 % in 2022.
Real GDP in Austria was estimated to have grown 4.8 % in 2022, according to the Institute for Advanced Studies (IAS), with the economy losing momentum in the second half of last year due to the sharp rise in energy prices, high uncertainty, and weaker international demand. Forecasts for economic growth in the fourth quarter are not expected to show further growth, as the twin drivers of the economy – industry and ski tourism – both suffered at the end of last year. In the coming year, the Austrian economy should stabilise after a sluggish winter period, and by the Spring, the economy is expected to stabilise, supported by easing inflationary pressures.
The IAS forecasts Austrian GDP to grow by 0.4 % in 2023 and 1.2 % in 2024, respectively, while inflation is expected to fall to 6.7% and 3.5% in the coming two years. Low international demand, high uncertainty among corporates and households and weak business confidence all reflect the high dependence on Russian gas. Austria imports around 90% of its gas consumption. Prior to the war, 80% of gas imports came from Russia. In November 2022, however, the share of gas imported from Russia had dropped to roughly 40%, according to data cited by ING. These dynamics will improve gradually, as a continued drag on corporate investment and consumer spending in the early New Year.
Austria’s PMI for manufacturing was 47.3 in December, the fifth-consecutive monthly contraction and below the eurozone average. The strong slump in demand put the brakes on cost increases and rise in output prices, according to the UniCredit Bank Austria Purchasing Managers’ Index. Manufacturers remain pessimistic about the outlook, despite easing price pressures, due to concerns about a broad economic slowdown, tightening financial conditions and high energy costs. Elevated labour shortages will prevent weakening employment growth from any significant increase in the unemployment rate, which is expected to remain around 6.5 % over the next two years, according to IAS.
Economic activity in Poland, central Europe’s biggest economy, looks to have slowed sharply in late 2022, as sluggish manufacturing production and retail sales underscored a challenging demand environment, economic uncertainty and high inflation. GDP is forecast to significantly slow in 2023 to 1.1% from an estimated 5.7% in 2022, according to Fitch Ratings, as international trade and domestic demand slow.
Private consumption was blunted by high inflation and weak consumer confidence, a trend expected to continue into 2023. Polish retail sales growth fell back sharply in December – at 0.2% higher than in December 2021 – compared to an increase of 13.1% in November 2022, according to Statistics Poland, with steep declines in furniture, TV and household appliances. Industrial output and new orders fell further, according to the S&P Global Poland Manufacturing PMI, while employment and purchasing continued to be cut.
The Polish economy faces recession risks as accumulative price growth over the past year weighs on consumer spending and sentiment, which puts pressure on corporates through lower demand, higher costs and more expensive debt servicing. However, the economy will see some support from the EU Cohesion Fund, designed to financially help EU member states with a gross national income per capita below 90% of the EU-27 average.
Annual CPI inflation in Poland declined to 16.6% in December, down from 17.5% in November and a record-high of 17.9% last October, according to the National Bank of Poland (NBP). Annual core inflation in December was 11.5%. The acute inflationary pressures are among the worst in the eurozone, which has sparked a public dispute over balancing the risks of excessive tightening against the dangers of protracted elevated price pressures. The NBP held its benchmark reference rate unchanged at 6.75% for the fourth consecutive time at its January 2022 meeting. Declining commodity prices are expected to support further inflation falls from March or April, but price pressures may swing back up in January, due to an increase in regulated prices, according to prime minister Mateusz Morawiecki in an interview at the World Economic Forum in Davos.