Angela Merkel’s Rosy World

Whichever coalition is formed in Germany, it starts on solid economic foundations with a rosy outlook.

angie-rosy-elections-germanyGermans have resoundingly voted Angela Merkel back into office on September 22, crediting her with Germany’s economic strength and good management of the vicious Eurozone crisis.

Unfortunately for her, she lost the junior coalition ally, the pro-business liberal FDP, and now has to tackle the upcoming challenges with a new partner from the center-left political spectrum.

Whichever coalition is formed, it starts on solid economic foundations with a rosy outlook. Since Easter, the economy is has been growing again. The ECB has stopped the market panic that threatened the common currency with its magic words and its rescue shield last summer.

Since then, economic confidence has been recovering in Germany and the wider Eurozone. The ECB’s expansive monetary policy of very low interest rates and generous liquidity provision, which had been toothless until July 2012, has started to gain traction as borrowing costs have declined across the currency zone.

Germany’s strong economic foundations, such as its super-competitive export sector, strong job creation and low unemployment, non-existent inflation, rising wages and a small fiscal surplus are starting to feed into a domestic-led recovery. Consumption is rising and investment into machinery and real estate staging a bounce-back. Germany looks set to return to near-trend growth in the second half of this year and into next year.

But Eurozone confidence remains fragile.

In 2013, at least five political crises have rocked the Southern periphery, where austerity and high unemployment continue to bite. All have been resolved fairly quickly, but Germany has had to ease a bit on its austerity demands. Confidence in the Eurozone’s banking system has not been fully restored yet.

Banking union may be the answer, but Germany cannot write a blank check to the Eurozone, back-stopping the currency zone’s banking system. Decision time for further progress is approaching fast, with an EU summit at the end of the month. And tail risks remain: Germany’s constitutional court will soon come out with its verdict on the ECB’s rescue shield. There is a tail risk that it limits the safety net the Eurozone recovery is built on too far.

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Germany itself is faced with long-term challenges. Its fertility rate is one of the lowest in the world. A shrinking and aging population may put even the relatively well-prepared pension and health care systems at risk. The changeover from nuclear and fossil energy production to renewables is costly.

The new government will have to set realistic targets to prevent a further erosion of its cost competitiveness. And finally, as in all countries which are doing well, complacency is a serious risk. The political discourse has shifted gradually away from generating more income to re-distributing existing income in a fairer way. That is often the start of long-term economic decline.

Dr. Christian Schulz joined Berenberg Bank in London as a Senior Economist in April 2011. He covers the Eurozone economy, the ECB, the German economy and global economy. Prior to Berenberg, he worked as an economist at the European Central Bank from 2008 to 2011, mainly in the Directorate General Payment Systems and Market Infrastructure. From 2003 to 2008, Christian was a consultant at The Boston Consulting Group in Frankfurt and Hamburg, Germany, where he was part of the Banking Core Group. Christian holds a doctorate in macroeconomics from the University of Hamburg. Read more articles by Christian.