Commentaries Monthly Report – October 2024

Article from the Monthly Report

1 Economic conditions

1.1 German economy still stuck in period of weakness

Real gross domestic product (GDP

) is likely to have contracted again somewhat in the third quarter of 2024. Output in the industrial sector and in construction probably declined markedly, with demand in both sectors remaining weak. This is likely to be due in part to the still comparatively high financing costs, which are dampening investment activity and thus demand for capital goods. Continuing uncertainty with regard to future economic and political conditions is also likely to be weighing on investment, as it impairs planning security for enterprises.
1
For the measurement of economic policy uncertainty, see, for example, the index developed by Baker et al. (2016). For Germany, this index picked up markedly again in September and is at a very high level.
Foreign demand for German industrial products is currently recovering only slightly, despite moderate growth in German sales markets. This indicates ongoing competitiveness issues. As a result, both domestic and foreign demand for German industrial products remains weak. The consequently now low level of capacity utilisation in the manufacturing sector is, in turn, taking its toll on the respective investment. At the same time, service providers are likely to have provided support to the economy in the third quarter, albeit to a limited extent, because private consumption probably provided only little impetus as consumers remained unsettled. The increase in their real incomes is intact as wages are rising significantly more strongly than prices. However, they were still hesitant to make use of this additional scope for expenditure. In the fourth quarter, economic activity could from today’s perspective more or less stagnate. Although the German economy is currently still not expected to see a recession in the sense of a significant, broad-based and prolonged decline in economic output, it remains stuck in the period of weakness that has persisted since mid-2022.
2
In addition to cyclical factors, structural adjustments also play a role here. This is indicated, for example, by the prolonged period of weakness in industry and competitiveness problems in the export sector. In addition to the longer-term effects of the energy price shock triggered by the Russian war of aggression against Ukraine, numerous other challenges exist for Germany as an industrial location (such as demographic change or the green transition) and for the position of German enterprises in global markets, for example due to increasing competition from China, see Al-Haschimi et al. (2024).

Gross domestic product in Germany
Gross domestic product in Germany

1.2 Industrial activity weak on a wide scale

Industrial output expanded recently thanks to a very strong increase in motor vehicle and motor vehicle parts production, but declined markedly on average in July and August. Seasonally adjusted

3
Seasonal adjustment here and in the remainder of this text also includes adjustment for calendar variations, provided they can be verified and quantified.
German industrial output rose sharply in August compared with July, recouping its decline from the previous month. Nevertheless, average output for July and August was markedly below the level of the second quarter. The August increase was almost solely attributable to the manufacture of motor vehicles and motor vehicle parts. Such a steep rise following the sharp fall in July suggests that this was attributable, in large part, to special factors such as the timing of plant shutdowns. Aside from the automotive industry, taking the average of July and August, the fall in output was fairly broadly spread across sectors.
4
Besides the manufacture of motor vehicles and motor vehicle parts, on an average of July and August, only other transport equipment and the repair and installation of machinery rose considerably compared with the second quarter.
Averaged across July and August, output in the energy-intensive sectors was also somewhat below the level of the previous quarter, meaning that the recovery they experienced in the first half of the year did not continue. According to the ifo Institute, companies in the manufacturing sector assessed their business situation in the third quarter as significantly worse compared with the previous quarter, which is consistent with the picture of weak industrial activity overall.

The slight signs of recovery in foreign demand for German industrial products weakened recently. Seasonally adjusted new orders in German industry decreased strongly in August 2024. Prior to that, they had risen sharply for two consecutive months, in July thanks in particular to a number of large orders.

5
Other transport equipment (aircraft, ships, trains, military vehicles) accounted for several major orders here, see Federal Statistical Office (2024a).
Taking the average of July and August, industrial new orders were therefore still well above the average of the second quarter. The decline in August is partly because significantly fewer large orders were received than in the previous month. However, the underlying trend in industrial new orders (i.e. excluding volatile large orders) also declined significantly compared with July. Taking the average of July and August, new orders without large orders were thereby markedly below the average of the second quarter. Domestic demand remains the main factor in this decline. By contrast, signs of a recovery in foreign demand for German industrial products remained evident, but weakened. After new orders from abroad (excluding large orders) increased sharply in July, thanks to considerably more orders from the euro area, they actually declined to a slightly greater extent in August. Nevertheless, taking the average of July and August, they remained above the level of the previous quarter. In line with the overall weak demand for German industrial products, ifo business expectations in the manufacturing sector as well as short-term production plans and export expectations deteriorated significantly again in the third quarter. An uptick in industrial activity in the near future therefore looks unlikely.

German industrial output and industrial new orders
German industrial output and industrial new orders

1.3 Probably only little impetus from private consumption

Despite favourable conditions, private consumption is unlikely to have given much impetus to economic activity in the third quarter. The conditions for a strong expansion of private consumption are actually good. Wages are now rising significantly more strongly than prices, which increases consumers’ real disposable income. In line with this, income expectations have risen in the first three quarters of the year, and particularly in the second quarter, according to surveys of the consumer research institution, Gesellschaft für Konsumforschung (GfK

). Furthermore, despite some cooling tendencies, the outlook for the labour market has been relatively stable so far. Nevertheless, households remained unsettled in the third quarter and were reluctant to use their additional spending leeway. Consumer sentiment measured by the GfK consumer climate index improved markedly in the third quarter, but remained at a low level. It is a similar story with the propensity to purchase. By the same token, the propensity to save remained at a very high level, even edging up again somewhat in the third quarter after a marked decrease in the second quarter. Economic concerns were probably also a factor in this, as economic expectations declined slightly again. Other private consumption indicators give mixed signals for the third quarter. Motor vehicle registrations by private owners fell significantly compared with the previous quarter, for example. The fact that the ifo business situation deteriorated substantially in trade in the third quarter and significantly elsewhere in the services sector also suggests that private consumption is rather subdued. By contrast, averaged across July and August, real retail sales, for which the Federal Statistical Office recently resumed its regular economic reporting with the results for August, were markedly higher than the average of the second quarter.
6
For an extended period, seasonally adjusted sales in the trade and services sectors were published only with a large lag. This made a timely assessment of developments in private consumption and for service providers more difficult. On 10 October 2024, the Federal Statistical Office resumed its regular economic reporting in these areas by publishing calendar and seasonally adjusted retail sales for August. The phased publication of respective results for sales in the services sector, as well as in the wholesale trade, motor vehicle trade and hospitality sector should follow shortly. See Federal Statistical Office (2024b). Until then, however, uncertainty about developments in these areas remains heightened.
Overall, private consumption is nevertheless likely to have provided only little impetus.

1.4 Labour market somewhat weaker

Unfavourable economic developments are beginning to have an impact on the labour market, although its response to the weakness is still relatively mild. The level of employment in Germany declined in August. Seasonally adjusted figures show that 21,000 fewer people were in employment overall than a month earlier. By contrast, employment subject to social security contributions rose at the current end, although this relates to the month of July. Initial projections by economic sector confirm the current trend: those areas of the manufacturing and retail sectors that are particularly affected by weak demand are increasingly reducing staff. On the other hand, recruitment was substantial in healthcare and social services, education, logistics and, most recently, also in the financial sector. As before, short-time work is almost exclusively used in the manufacturing sector, with its use hardly rising over the past few months. However, there is currently also no facilitated access for firms wishing to use short-time work, such as had been temporarily introduced in previous severe economic crises.

Labour market in Germany
Labour market in Germany

From today's perspective, it is unlikely that employment levels will decline significantly. The short-term indicators for the next few months remain mixed. The ifo

employment barometer, which ascertains recruitment plans in trade and industry over the next three months by questioning a sample of enterprises, paints a particularly negative picture. Especially companies in the manufacturing and retail sectors plan to (further) reduce the number of employees. Employment plans in construction and other commercial services are neutral to positive. The employment barometer of the Institute for Employment Research (IAB) for the economy as a whole is more stable and remains in positive territory. For the first time in a long while, the number of vacancies reported to the Federal Employment Agency barely declined further in September. At the same time, the number of vacancies is still comparatively high, and vacant positions often take a long time to fill.

Unemployment up again somewhat in September. After seasonal adjustment, around 2.82 million people were registered as unemployed, 17,000 more than in August. The unemployment rate held steady at 6.0% due to rounding. Only unemployment under the cyclically sensitive statutory unemployment insurance scheme posted an increase, whereas the number of unemployed receiving the basic welfare allowance remained unchanged. It is currently difficult for unemployed people to get back into employment. The outflow rate from unemployment into employment is very low. Structural change probably plays a part in this, as workers in the industrial sector are being dismissed, while there is urgent demand for childcare staff and carers. This is another reason why unemployment is rising despite the ongoing shortage of labour. However, registered unemployment is expected to rise only moderately over the next few months. The IAB

unemployment barometer is only just below the neutral threshold. The number of people, who register with the Federal Employment Agency as looking for work as they expect to be out of work soon, is also not significantly elevated so far.

1.5 Energy commodity prices recently rose slightly

Following declines in September, energy commodity prices temporarily picked up in October. Crude oil prices, in particular, increased at the beginning of October given the further escalation of conflicts in the Middle East. After related concerns about potential oil supply shortages faded, crude oil prices dropped again as well. Furthermore, indications of lower oil demand, particularly in China, and the prospect of an oversupplied global oil market in 2025 had a dampening effect on prices. As this report went to press, a barrel of Brent crude oil cost US$77, which is roughly the same as in September. European gas prices also picked up somewhat in October as a result of the geopolitical tensions.

1.6 Inflation rate drops to 1.8% in September

Price dampening signals were observed recently at the upstream stages of the economy. In industrial domestic sales, seasonally adjusted prices decreased in September compared to the previous month for the first time since the beginning of the year. This was due in particular to a strong drop in energy prices. Import prices (with and without energy) likewise fell strongly in August the most recent month for which data are available. Overall, industrial producer prices were still just over 1% lower than a year earlier. Import prices were only marginally above their previous year’s level.

The inflation rate continued to decline in September. The Harmonised Index of Consumer Prices (HICP

) was unchanged from the previous month in seasonally adjusted terms, as in August. Energy prices, in particular, fell substantially once again. By contrast, prices for food, especially fruit and vegetables, climbed significantly. Industrial goods (excluding energy) became somewhat more expensive as well. With the exception of travel services, price dynamics for services remained high on a broad basis. Annual headline inflation fell from 2.0% in August to 1.8% in September. By contrast, the core rate excluding energy and food persisted at 3.0%.

The inflation rate is likely to be higher again towards the end of the year. The inflation rate is expected to pick up again in the coming months. This is due, amongst other things, to energy base effects. Crude oil prices peaked in September of last year and then fell again. Taken in isolation, this will contribute to an increase in the headline HICP

rate over the coming months. A higher inflation rate is also expected for food as commodity prices went up recently. Finally, services inflation is likely to remain elevated for a while. Against the backdrop of steeply rising wages, disinflation in this area continues to be much slower than in the case of industrial goods (excluding energy).

Headline and core inflation in Germany
Headline and core inflation in Germany

2 Public finances

2.1 Local government finances

Local governments (core budgets and off-budget entities) closed the first half of 2024 with a very large deficit of €17 billion. It by far exceeded the level recorded for the same period one year earlier, namely by €10 billion.

The statistical reclassification of local public transport companies further boosted revenue and expenditure, but is unlikely to have significantly affected the balance.

7
See Deutsche Bundesbank (2023), pp. 8-10.
Since the second quarter of 2023, local public transport companies pertaining to local government have been classified as off-budget entities in the general government sector (i.e. no longer in the corporate sector). Given that they did not yet count as part of the general government sector for the entire first half of 2023, the corresponding government revenue and expenditure items rose sharply on the year. This statistical effect mainly affects off-budget entities. To eliminate this effect, this commentary focuses on core budget developments.

Revenue in the core budgets increased by just under 3½% (+€5 billion) on the year in the first half of 2024. Tax revenue stagnated, however. Although the large revenue item local business tax (after deduction of shares accruing to other government levels) still rose by 3% (+€1 billion) on account of a stronger development in the first quarter, income tax shares, on the other hand, fell sharply, by 9% (-€1½ billion). This was due to their excessively high level in the year prior, when relatively high back payments were settled in the first half of the year.

8
See also Deutsche Bundesbank (2024).
The major item general purpose grants from state government grew moderately (+2½% or €½ billion). Growth had been significantly higher one year earlier, given that state governments’ tax revenue, on which the grants are largely based, had previously expanded a great deal more sharply. The increase in revenue from fees was somewhat more dynamic, at 4½% (+€½ billion), Local governments evidently increased their fees, not least due to higher costs.
9
The statistical reclassification of local public transport companies was reflected in off-budget entities’ revenue from fees. The increase in the first quarter amounted to just under 25% for core budgets and off-budget entities combined (14% in the first half of the year).

At 9% (+€14 billion), the rise in core budget spending was considerably more pronounced than the increase in revenue. This is probably a reflection, not least, of higher prices. Spending on personnel likewise rose by 9%, contributing almost €3½ billion to the increase in expenditure. The sizeable wage agreement of last spring had so far only made a minor impact in the first half of 2023. At 7% (+€2½ billion), other operating expenditure posted only somewhat weaker growth. The increase in expenditure on social benefits of just over 12% (+€4½ billion) was particularly strong, with contributions from all larger sub-categories such as integration assistance, social assistance, assistance for young people and accommodation costs (basic allowance benefits). Fixed asset formation saw a below-average increase of 6% (+€1 billion). The considerably poorer financial situation since last year may already have had a dampening effect in this context.

Local government can expect a higher deficit for the year as a whole as well (2023 deficit for core budgets and off-budget entities: €7 billion). This is because expenditure growth is likely to remain high in the year as a whole, irrespective of less dynamic increases in the major item personnel expenditure from the summer onwards.

Pressure on local government finances is set to subside to some extent in the years that follow, but a fundamental recovery is currently not in sight. There is likely to be solid growth in tax revenue going forward, even when taking account of revenue shortfalls stemming from the growth initiative as laid out in the draft legislation. In addition, it remains to be seen how the changeover to the new real estate tax – which is structured differently from state to state – will play out. On the one hand, legal objections have been raised, which is indicative of default risk.

10
See, for example, Schwarting (2024).
On the other hand, local governments are able to raise multipliers in order to generate additional revenue from real estate tax to close fiscal gaps.
11
For the reporting year 2023, for which figures were recently published, the Federal Statistical Office recorded only a moderate increase in the average real estate tax B-multiplier of 7 points to 493%. See Federal Statistical Office (2024).
Growth rates on the expenditure side are likely to decline significantly as price pressures resulting from the high rates of inflation over the last few years are set to subside. As a result, the pressure on local government finances is likely to ease in some areas. However, local governments are facing political challenges requiring additional expenditure as well. Examples include the further expansion of childcare and local public transport facilities, and urban planning measures for adapting to climate change. Consequently, a significant easing of the financial situation is not foreseeable at present.

It is essential that political challenges are not resolved at the expense of sustainable local government finances. The federal states must prevent a renewed increase in multi-year local government cash advances.

12
See also Deutsche Bundesbank (2021).

Local government fiscal balance
Local government fiscal balance

List of references

Al-Haschimi, A., L. Emter, V. Gunnella, I. Ortdoñez Martínez, T. Schuler und T. Spital (2024), Why competition with China is getting tougher than ever, The ECB

Blog, 3 September 2024.

Baker, S., N. Bloom and S. Davies (2016), Measuring Economic Policy Uncertainty, The Quarterly Journal of Economics, Vol. 131, Issue 4, pp. 1593 - 1636.

Deutsche Bundesbank (2024), Commentaries, Public finances, Monthly Report, April 2024.

Deutsche Bundesbank (2023a), Commentaries, Public finances, Monthly Report, October 2023, pp. 8-9.

Deutsche Bundesbank (2021), Local government finances: how cash advances can be limited and budget imbalances avoided, Monthly Report, June 2021, pp. 53-58.

Federal Statistical Office (2024a), New orders in manufacturing in July 2024: +2.9% on the previous month, press release No 335 of 5 September 2024.

Federal Statistical Office (2024b), Wiederaufnahme der monatlichen Statistiken im Handel und im Dienstleistungsbereich.

Federal Statistical Office (2024c), Realsteuervergleich 2023, EVAS

number 71231.

Schwarting, G. (2024), Die Grundsteuer vor Gericht – Gefahr für das Bundesmodell?, in: Der Gemeindehaushalt 1/2024, pp. 16-19.

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