Slowing German growth worrying sign for rest of Europe

Economy considered engine of Euro area shrinks 0.2% in June quarter

Cracks are emerging in Germany's once rock-solid economy as companies' reluctance to invest bears out Mario Draghi's warning that the Euro-area recovery is in danger.

Gross domestic product in Europe's largest economy shrank 0.2% in the second quarter, the Federal Statistics Office said on Monday, confirming an August 14 estimate. While part of the drop can be attributed to a mild winter that front-loaded output earlier in the year, the Bundesbank has cast doubt on a second-half rebound and suggested its forecasts may prove too optimistic.

The weakness of a German economy that has outperformed its peers since the regional debt crisis comes as European Central Bank President Draghi ponders adding more stimulus to fight the threat of deflation in the currency bloc. He signalled that declining inflation expectations could tip the ECB into broad-based asset purchases, an option officials may discuss at this week's policy-setting meeting.

"A weaker German economy weighs on Europe," said Michala Marcussen, global head of economics at Societe Generale SA in London. "The Euro area is falling into a lowflation trap with annual growth and inflation rates stuck between zero and 1 percent. The ECB probably won't act this time, but I expect Draghi to reiterate his Jackson-Hole message."

All instruments
Policy makers will use "all the available instruments needed to ensure price stability" and are "ready to adjust the policy stance further," Draghi said on August 22 in the Wyoming mountain retreat that hosts the Federal Reserve Bank of Kansas City's annual economic symposium. The ECB's Governing Council will set monetary policy on September 4 in Frankfurt.

Capital investment slumped 2.3 per cent in the second quarter, with construction declining 4.2 per cent, the statistics office said. Private and government consumption each rose 0.1 per cent. Exports climbed 0.9 per cent and imports were up 1.6 per cent.

Investment was the biggest drag on the economy, subtracting 0.5 percentage point from GDP. Net trade cut 0.2 percentage point, while inventories added 0.4 percentage point.

The drop in investment partly reflects the fact that it surged at the beginning of the year, as a warm winter boosted construction. Even so, the decline also highlights companies' hesitation to invest amid political tensions in Ukraine, Russia and West Asia.

Germany is the Euro area's biggest exporter and Russia counts the nation as its biggest trading partner after China. German investor confidence in August was the weakest since 2012 and business sentiment slid for a fourth month.

'Clouded over'
"The economic outlook for the German economy has clouded over in the middle of the year in response to unfavourable international news," the Bundesbank said in its monthly report published on August 18. "Expectations for a strengthening of economic momentum in the second half of 2014 underlying the spring projections are called into question by current data."

The Bundesbank predicted in June that the German economy will expand 1.9 per cent this year and 2 per cent in 2015. That compares with ECB forecasts of Euro-area growth of 1 per cent and 1.7 per cent, respectively. The ECB will publish new projections for the currency bloc this week, while Bundesbank estimates for Germany are due in December.

Manufacturing PMIs
With the 18-nation economy stagnating last quarter and a final survey of purchasing managers showing manufacturing activity at the weakest in more than a year in August, the ECB may downgrade its economic outlook. Inflation in the region slowed to 0.3 percent last month, compared with the central bank's goal of just under 2 per cent.

Consumer-price gains haven't been near the ECB's threshold since the beginning of last year and Draghi cited sliding inflation expectations as a reason for concern. Economists from Citigroup Inc to Commerzbank AG predict policy makers will ultimately have to respond with a quantitative-easing programme.

"It's no secret that we are seeing somewhat of a downturn in the economy," ECB Governing Council member Ewald Nowotny said last week. "Germany is no longer able to be a locomotive for growth."