Deutsche Bundesbank Monthly Report May 2021 5

The current economic situation in Germany Deutsche Bundesbank Monthly Report May 2021 6

Overview

Light at the end of the dustrial goods caused commodity prices to in- tunnel­ crease considerably, and transport costs rose steeply. This cost surge most recently affected Subdued start to The pandemic maintained a firm grip on the industrial producer prices perceptibly and will year for global global economy in the first quarter of 2021 as probably have an impact on consumer prices, economy well. In many places, new waves of infections too. and tighter containment measures set the re- covery back. Services were once again particu- In the meantime, vaccination campaigns have Vaccination larly affected. Towards the end of the reporting taken off in many places, and in a great num- progress­ holds out hope for period, supply shortages were a drag on indus- ber of advanced economies infection rates opening try, which had initially experienced a lively ex- have flattened markedly. It appears that, as pansion. This also drove industrial producer from the third quarter if not beforehand, it will prices up. On the whole, the global economy be possible to open the economy in those continued its recovery in the first quarter, yet at places on a broad scale, which would lend sig- a distinctly reduced pace. In the euro area, nificant momentum to the global economic gross domestic product (GDP) was even down recovery­. by 0.6% from an already weak preceding quar- ter. Japan and the United Kingdom likewise ex- The international financial markets reflected Financial perienced a marked drop in activity. By con- this outlook for an economic recovery. Market markets­ reflect- ing more favour- trast, the economic recovery took off again in participants’ confidence was boosted by pro- able economic the United States, where many restrictions gress in vaccinations, positive business cycle outlook were already lifted over the course of the first signals and an accommodative monetary policy quarter and extensive stimulus packages gave stance. Given simultaneous fiscal policy stimu- the economy an additional boost. In China, lus – particularly in the United States – yields on where the pandemic has already been under benchmark government bonds rose world- control for quite some time now, the economy wide, at times distinctly, via the interest rate continued to recover, whereas some other linkage with the United States. This rise in yields emerging market economies suffered from the occurred in a setting of calm markets and high economic fallout caused by new waves of in- liquidity. A key factor behind the increase in fections. risk-​free interest rates was mounting inflation expectations, which continued to pick up from Supply-​side The industrial sector was one of the main rea- their low in March 2020 on both sides of the bottlenecks a sons why the global economy remained on a Atlantic. Real interest rates therefore rose less drag on global industrial upturn path of expansion in the final quarter of 2020 strongly, on the whole, than nominal govern- and first quarter of 2021, despite new waves of ment bond yields. In January 2021, yields on infections. It benefited considerably from the euro area corporate bonds initially hit all-​time pandemic-​induced shifts in demand. Since its lows before then rebounding as well. They drastic slump in the spring of last year, global nonetheless continued to reflect very favour- industrial production had already grown sub- able financing conditions as this report went to stantially, surpassing its pre-​crisis level in De- press. The upbeat setting led to strong price cember 2020. At last report, however, the up- gains in the equity markets. Alongside the turn in manufacturing was running into supply-​ aforementioned factors, this also reflected side bottlenecks. Purchasing managers the enterprises’­ higher profit expectations and in- world over complained about rising delivery vestors’ high risk appetite, which dampened times. In addition, the strong demand for in- demand in the foreign exchange markets for Deutsche Bundesbank Monthly Report May 2021 7

some currencies regarded as relatively safe. the persistently low level of interest rates en- Consequently, the yen and Swiss franc lost couraged these sectors to continue to accumu- value in effective terms. The euro also depreci- late, in particular, highly liquid overnight de- ated on a weighted average, though its losses posits. On the counterparts side, the Eurosys- were small by comparison. Given rising yields tem’s continued asset purchases boosted mon- on US Treasuries, the effective exchange rate of etary growth. Moreover, banks’ lending to the the US dollar, which also often depreciates domestic private sector once again registered when risk appetites rise, remained virtually un- significant inflows on balance. It was particu- changed. By contrast, the pound sterling bene- larly loans to non-​financial corporations which fited from the trade and cooperation agree- picked up substantially in some Member States ment with the EU reached at the end of 2020 during the quarter under review; households’ and the United Kingdom’s successes in its vac- demand for loans for house purchase also re- cination campaign. mained lively. At the same time, the banks par- ticipating in the Bank Lending Survey (BLS) re- Monetary Following its March and April monetary policy ported mostly tightening their credit standards policy­: ECB Gov- meetings, the Governing Council of the Euro- due to elevated risk related to the pandemic. erning Council expecting higher pean Central Bank (ECB) expected purchases monthly PEPP German eco- purchases in Q2 under the pandemic emergency purchase pro- Aggregate output in Germany fell strongly in gramme (PEPP) over the second quarter to be the first quarter of 2021. According to the Fed- nomic output down strongly conducted at a significantly higher pace than eral Statistical Office’s flash estimate, real GDP in Q1 2021 during the first few months of the year. This was 1.7% down on the quarter after seasonal position was based on an assessment of devel- and calendar adjustment. This meant that eco- opments in financing conditions since the be- nomic activity again fell short of the pre-​crisis ginning of the year, especially of the rise in level of the fourth quarter of 2019 by almost market rates over this period. At the same time, 5%. The setback can be attributed in large part the Governing Council reaffirmed its decision to the stricter and more prolonged measures to taken in December 2020 to continue to con- protect against coronavirus compared with the duct net purchases under the PEPP with a total preceding quarter. In particular, this hit a num- envelope of €1,850 billion until at least the end ber of services sectors hard. Moreover, indus- of March 2022 and, in any case, until it judges trial output stagnated, and construction output that the coronavirus crisis phase is over. If even declined, after both sectors had provided favour­able financing­ conditions can be main- considerable support to the economy in the tained with smaller asset purchase flows over- previous quarter. Various factors were at work all, the envelope of €1,850 billion need not be here. In the construction sector, the return of used in full. Equally, the envelope can also be the VAT rates to their higher levels at the start increased if required. of the year and the unfavourable weather con- ditions in January and February had a dampen- Monetary In the first quarter of 2021, the broad monetary ing effect. In industry, bottlenecks in the supply dynamics still aggregate M3 once again went up steeply on of intermediate goods led to the recovery stall- strong on account of account of the impact of the coronavirus pan- ing, despite a further increase in demand. The coronavirus pandemic demic and the economic policy responses. Al- automotive sector experienced delays in pro- though monetary dynamics slowed down con- duction owing to a lack of semiconductors. siderably compared with the situation at the outbreak of the coronavirus crisis a year ago, On the demand side, it was probably, above all, Strong signs of the annual growth rate of the broad monetary private consumption which declined strongly in slowdown, mainly in private aggregate M3, at 10.1% at the end of March, the first quarter. A host of opportunities for consumption remained high. Precautionary considerations consumption of services were either partially or on the part of households and enterprises and entirely unavailable owing to the coronavirus Deutsche Bundesbank Monthly Report May 2021 8

mitigation measures. In addition, the return of second half of 2020. As the mitigation meas- VAT rates to their higher level dampened de- ures first began to be eased in March and pro- mand for consumer durables such as motor gress on vaccinations advanced, the labour vehicles.­ Purchases of such goods had been market also saw a return of confidence in de- brought forward to the second half of the pre- velopments over the next few months. vious year. Businesses probably reduced invest- ment in new machinery and equipment in the Negotiated wages recorded only a moderate Negotiated first quarter as well, albeit on a much smaller rise in the first three months of 2021. Including wages up only moderately due scale. On the other hand, German enterprises additional benefits, they were up by just 1.4% to pandemic; actual earnings continued to benefit from dynamic foreign de- on the year in the first quarter. The increase in probably even mand and significantly increased their exports. the fourth quarter of 2020 had still stood at down 2.6%. The most recently concluded new agree- Fresh uptick in The depressed level of private consumer ex- ments were a key factor behind this weaken- German banks’ penditure also dampened demand for con- ing. They initially provide for pay freezes of sev- loans to domes- tic private sector sumer credit. Nonetheless, the lending business eral months at the start of the contracts, fol- of banks in Germany grew dynamically on the lowed by low wage increases only around one whole, for two reasons. One was that house- year into the contracts. In addition, one-off​ hold demand for loans for house purchase re- coronavirus special payments had been made mained consistently strong. The other was that in a number of sectors in the fourth quarter of loans to non-​financial corporations gained sig- last year. Wage bargainers restricted agreed nificant momentum compared with the two wage increases in order to protect jobs. With preceding quarters. This was caused by a grow- short-​time work having gone back up in the ing need for funding on the part of those en- first quarter, actual earnings may even have terprises not directly impacted negatively by fallen. As in the previous three quarters, wage the coronavirus crisis, such as enterprises in the drift is likely to have been clearly negative. construction and real estate sectors and service providers operating in the field of digitalisation Consumer prices as measured by the Harmon- Due primarily to and research and development activities. The ised Index of Consumer Prices (HICP) rose ex- return of higher VAT rates, con- upswing in global industry has also acted to ceptionally strongly at the beginning of the sumer prices at start of year up stimulate investment by export-​oriented sec- year. On average for the months of January to sharply on the tors. In addition, some banks had a heightened March 2021, they increased by a seasonally ad- quarter … interest in lending business as well. They were justed 2.1% on the quarter, after having previ- still trying to reach, by the end-March​ reference ously stagnated. The main reasons for this were date, their lending performance threshold set the reversal on 1 January of the temporary VAT as the condition for the particularly attractive cut, but also measures contained in the climate interest rate on TLTRO-​III operations. On the package and the higher oil price. Overall, prices whole, however, respondents to the BLS once for all the main components of the HICP basket again somewhat tightened their credit stand- rose strongly, with the higher VAT rates in Janu- ards for loans to enterprises in the first quarter. ary 2021 being passed on in a more or less in- verse manner to their reduction in July 2020. Labour market The labour market responded robustly to the While the inflationary pressures for food, non-​ robust prolonged mitigation measures in the first energy industrial goods and services normal- quarter. Both employment and unemployment ised again by March, energy prices continued held nearly steady at the level of the fourth to rise significantly, tracking crude oil prices. quarter of last year. The effects of the lower economic output were largely cushioned by The return to the higher VAT rates also had a … and on the short-​time work, which was again taken up on clear impact on the annual increase in the HICP, year a much larger scale after the decline in the with inflation up from -0.6% in the fourth quar- Deutsche Bundesbank Monthly Report May 2021 9

ter of 2020 to 1.7% in the first quarter of 2021. German economic output is likely to grow Economic Excluding energy and food, inflation increased again significantly in the second quarter of output­ likely to grow consider- from -0.1% to 1.8%. A statistical effect in con- 2021. The extent of this growth will depend ably in second nection with the more extensive pandemic-​ largely on how heavily the containment meas- quarter related updates to the expenditure weights ures weigh on the economy in comparison to underlying the HICP, particularly in the case of the first quarter. As soon as the measures to package holiday prices, also played a role here. protect against the coronavirus are successively loosened, activity in the affected services sec- Inflation rate in The annual rate of inflation rose again slightly tors should pick up again considerably. The in- April up further in April to 2.1%, compared with 2.0% in March. dustrial sector is benefiting from strong de- due to energy and food Energy inflation in particular increased sharply mand, with industrial orders recently seeing a of late, but food inflation also picked up signifi- further strong rise from their already elevated cantly. By contrast, the core inflation rate ex- levels. Manufacturing firms have recently as- cluding energy and food fell from 1.6% in sessed the business situation as having im- March to 1.1%. However, a decisive factor here proved again and have once more raised their was the reduced contribution of the statistical production and export expectations. However, effect for package holidays, which had pushed industrial output will probably continue to be up the HICP rate significantly in the previous subdued in the near future owing to bottle- months. necks in the supply of intermediate goods. Output in the construction sector is likely to re- Inflation rate set In the coming months the rate of inflation is bound once dampening one-​off effects cease to rise further likely to continue on a slow upward trajectory to apply. Business expectations brightened on a and could tem- porarily reach at first. While the recent strong rise in the prices broad cross-​sectoral basis. Rapid progress in 4% at end of year of non-​energy commodities and transport costs the vaccination campaign opens the prospect is already having a very significant impact on of a considerable loosening of containment input prices at the producer level, this develop- measures in the coming months. GDP could ment is not feeding through directly to con- then grow strongly in the third quarter and ex- sumer prices. Consumer prices are correlated ceed its pre-​crisis level as early as the fourth more closely to producer prices for non-food​ quarter. consumer goods, which have thus far risen rather ­moderately. Furthermore, distribution To date, the fiscal policy response in Germany Targeted fiscal costs and margins are also major determinants has been flexible and, overall, targeted to the policy for the most part of consumer prices. The upward pressure on difficult crisis situation. Although, in some cases, prices in the earlier input stages is therefore the specific design and implementation of indi- likely to have merely a weakened and delayed vidual measures are less than convincing, it impact on consumer prices. As far as headline should be borne in mind that action sometimes HICP inflation is concerned, a significant factor had to be taken fairly swiftly and subsequently is that the base effect resulting from the tem- fine-​tuned as the pandemic unfolded, for ex- porary VAT cut will raise the annual rate as of ample. July. However, this is likely to be almost com- pletely obscured at first due to the statistical Public finances have continued to significantly Public finances effect­ for package holidays simultaneously hav- support the economy in 2021. The dedicated again providing strong support ing a dampening impact for several months. At coronavirus assistance measures and the regu- to the economy the end of the current year, however, this one-​ lar social systems are continuing to mitigate the in 2021 off effect will once again intensify inflationary economic fallout from the coronavirus crisis. To pressures. As a result, the inflation rate could combat the pandemic, sizeable funds are being temporarily rise to 4%. channelled into healthcare, for example for vaccinations and tests. Above and beyond that, Deutsche Bundesbank Monthly Report May 2021 10

various structural measures are providing relief given escape clause is still necessary to over- for households in particular; for example, the come the crisis. Due to the German general solidarity surcharge has been partially abol- election, the 2022 Federal budget probably will ished and child benefits have been raised sig- not be adopted until next year in any case. Be- nificantly. sides, even without the exemptions, the fiscal rules provide scope for reducing deficits in a Deficit likely to Germany’s general government deficit could cyclically appropriate manner. For example, continue rising therefore approach around 6% of GDP this under the debt brake reserves can be used to in 2021 year, up from just over 4% in 2020. The bulk of comply with the ceilings. Under EU rules, expir- the fiscal burdens presented by the crisis are ing assistance measures will be deemed to con- being borne at the central government level. As stitute consolidation. It should therefore be things currently stand, however, it seems that possible for other Member States to meet the the buffers in the Federal budget are very standard requirements as well. At least on the ample and far from being exhausted. Net bor- basis of the European Commission’s most re- rowing by central government in 2021 would cent projection, use of the escape clause in therefore again be considerably lower than the 2022 does not seem convincing. very high budgeted figure. The debt brake is sometimes criticised for hav- Fiscal rules do not prevent add- Deficit expected As long as the pandemic-​related restrictions ing excessively restricted government activities itional spending to shrink consid- continue, targeted fiscal assistance will remain and spending in recent years. However, this is for future tasks erably in 2022 important. However, it is currently anticipated belied by the dynamic expenditure growth that the restrictions will increasingly be lifted as under the debt brake regime. For the coming the year progresses. In 2022 it is likely that the years it even appears that non-interest​ expend- deficit will then shrink considerably. The burden iture as a share of GDP will reach new struc- on public sector budgets will be relieved by the tural highs. The fiscal rules are not in any case ongoing recovery in the German economy and designed to limit government spending. Rather, the fact that numerous support measures will the rules are meant to keep the government no longer be necessary and will be phased out; budget in an agreed state of balance or to re- the fiscal policy stance is in this respect not re- vert it to such a state. This means matching strictive. revenue and expenditure and setting priorities. If funds for important future tasks are con- Decision on With regard to the fiscal rules, there is much to sidered to be insufficient, various courses of -ac necessity of be said for putting off a decision on whether tion are available. If the fiscal burden is not to escape clause in 2022 should the escape clauses should also remain activated be increased, say due to negative impacts on wait until later this year in 2022 until later in the year. This applies in growth, the political priorities or adopted equal measure to the EU rules and the debt spending programmes would have to be re- brake. This is because as the year progresses it adjusted. will become much easier to assess whether the