The global economy continued to expand moderately in the spring, albeit with regional differences. In China, flagging domestic demand depressed economic growth. In the euro area, the growth seen at the beginning of the year continued. However, there is no sign of a strong, broad-based upswing. In the United States, by contrast, economic activity remained fairly buoyant. Economic growth there was even somewhat stronger than at the beginning of the year.

Global industrial activity continued to pick up in the second quarter, but the short-term outlook has recently deteriorated again somewhat. Industrial output rose significantly, particularly in the United States and Japan. The global industrial recovery thus broadened. The euro area remained a key exception. There, output continued to decline in the second quarter. Global trade increased in line with global industrial output. According to the results of recent surveys of purchasing managers, however, the global industrial recovery may have stalled of late. Industrial output probably barely inched upwards in July, and new orders fell.

Disinflation in the advanced economies is continuing to progress at only a slow pace. Up to July, the year-on-year rate of consumer price inflation in that group of countries contracted to 2.7%. Three months earlier, it had stood at 3.0%. Efforts to contain core inflation achieved similarly modest progress. The inflation rate excluding energy and food stood at 3.0% in July, compared with 3.3% in April. A near-term return to the price stability targets is not yet on the cards. In labour-intensive services, in particular, upward pressure on prices remained stubbornly high, due in part to the persistently buoyant wage growth in many places.

Improved US inflation data as well as unexpectedly weaker economic signals reinforced expectations in international financial markets of rapid interest rate cuts. This had not been the case in the spring, when – in light of stalling disinflation and a robust economic environment, at least in the United States – market participants successively shifted their assessments of when a phase of interest rate cutting would begin in the United States and the euro area into the future. Since the beginning of the third quarter, there have been increasing changes in the financial market environment. Backed by the Federal Reserve’s assessment that progress had now been made in tackling US inflation, market participants adjusted their outlook for key interest rates, in some cases significantly downward. Later on, unexpectedly weaker labour market data from the United States reinforced this market dynamic. Due to their interlinkages with US interest rates, key interest rate expectations in the euro area fell, too. Overall, long-term yields developed heterogeneously. For instance, yields fell in the United States, while they hardly changed on balance in the euro area. These developments caused the euro to appreciate against the US dollar. By contrast, given rising yields in Japan, the euro depreciated against the yen in net terms.

Risky assets – including shares, in particular – came under pressure as the economic outlook clouded over and investors’ risk appetite diminished. With heightened financial market volatility, international equity markets temporarily incurred significant price losses in some cases. As risk appetite amongst investors declined, the yield spreads on long-term government bonds and corporate bonds widened slightly overall. Against this backdrop, investors demanded somewhat greater risk compensation for bonds with low credit quality. Subsequently, however, the surge in financial market volatility at the beginning of August caused by poorer US labour market data quickly abated. Developments in international equity markets since the beginning of the second quarter exhibit marked regional differences. The United States and the United Kingdom saw slight price gains on balance, while the euro area and Japan recorded losses.

At its monetary policy meeting in June 2024, the Governing Council of the ECB lowered the three key ECB interest rates by 25 basis points each. Amongst other reasons, the Governing Council justified the cut in key interest rates based on the fact that inflation had fallen by more than 2.5 percentage points since September 2023 and that the inflation outlook had improved markedly. At the same time, however, it emphasised that domestic price pressures remained strong as wage growth was elevated. Accordingly, inflation is likely to stay above target well into next year. However, it is then expected to fall to 2.0% at the end of 2025. Alongside its interest rate decision, the Governing Council also confirmed that it will reduce the holdings of securities under the pandemic emergency purchase programme (PEPP) by €7.5 billion per month on average over the second half of the year.

Following the interest rate cut in June, the ECB Governing Council left its key interest rates unchanged in July, stressing that it would not pre-commit to a particular rate path for the future. The Governing Council will keep policy rates sufficiently restrictive for as long as necessary. It will continue to follow a data-dependent and meeting-by-meeting approach to determining the appropriate level and duration of restriction. In particular, its interest rate decisions will be based on its assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation and the strength of monetary policy transmission. In this context, the ECB President notably emphasised at the press conference that the September interest rate decision, too, would be determined solely on the basis of all the data received by then.

The broad monetary aggregate M3 saw significant growth in the second quarter of 2024. The recovery in monetary growth observed since the fourth quarter of 2023 thus continued, with the annual rate coming to 2.2% at the end of June. This development is a reflection of households and enterprises completing the process of reallocating their portfolios in response to the rises in interest rates in 2022 and 2023. With the end of the interest rake hiking phase and the decline in capital market yields that has been observed since then, households and enterprises increasingly scaled back the volume of assets they shifted out of short-term bank deposits into non-M3 forms of investment. On the counterpart side, monetary growth was driven primarily by high demand among non-resident investors for euro area securities. Bank loans to non-financial corporations and households expanded only marginally on balance. According to the Bank Lending Survey (BLS), this came about because demand for loans was still subdued overall: credit standards were barely tightened any further or were even moderately eased in some cases.

Contrary to expectations, German economic output fell slightly in the second quarter of 2024. According to the Federal Statistical Office’s flash estimate, seasonally adjusted real gross domestic product (GDP) declined by 0.1% on the previous quarter. This preliminary result is very likely to be revised because important statistics for trade and services, which are included in the GDP estimate, are currently being published with a time lag and are not yet available for the last few months. GDP had increased by 0.2% in the first quarter. According to the flash estimate, particularly investment in new machinery and equipment and in new buildings dropped. Construction activity had been expected to normalise following an increase boosted by weather-related factors in the first quarter. However, there were other key headwinds besides these that persisted into the second quarter. Demand for industrial products from abroad remained weak, for example. Higher financing costs and heightened economic and political uncertainty dampened investment. Private consumers remained worried, which meant that the steep increases in wages have still not translated into an equally brisk uptick in consumption.

It was an environment in which credit developments also remained moribund. Lending to non-financial corporations moved sideways again on aggregate. Lending business with domestic households was also weak in the second quarter of 2024. Although housing loans were up on the second half of 2023, the rise was not as significant as in the previous quarter. Furthermore, banks’ lending policies had a dampening effect.

The labour market remained relatively stable despite the sluggish economic recovery. Employment rose moderately in the second quarter of 2024. However, the increase was not strong enough to fully absorb the number of workers available to the labour market, which is rising as a result of immigration. This is why the number of unemployed persons also went up somewhat. The ongoing economic weakness was also reflected in a moderate increase in short-time work and a slow decline in job vacancies. Not much change is expected in this development in the near future.

Negotiated wages continued to rise significantly in the second quarter of 2024. Inflation compensation bonuses that had been paid out in the previous year were discontinued, which dampened the year-on-year rate. Excluding these bonus payments, however, negotiated wages rose by 4.2% on the year in the second quarter, representing markedly stronger growth than in the first quarter. Permanent wage increases are gaining in importance. From a long-term perspective, the high growth in actual earnings is continuing.

High pay increases were likewise agreed in recent wage negotiations. In annualised terms, wage growth ranged between 4% and 6% in almost all sectors that concluded new collective agreements in the second quarter. High new pay deals are also pending in the forthcoming negotiations. The wage demands being made by trade unions are still high, currently ranging from 7% to 19% for 12-month agreements. Wage demands in services stand out in particular at present. Trade unions are looking to achieve lasting compensation for the real wage losses accumulated over the past three years. The still high willingness to strike and widespread shortage of labour suggest that wage increases will continue to be comparatively substantial in the future.

In the second quarter of 2024, inflation did not decline any further on the quarter. As in the first quarter, consumer prices (HICP) went up markedly in the second quarter, with a seasonally adjusted quarter-on-quarter rise of 0.8%. This was mainly due to the continued steep growth in the prices of services. The prices of some services were probably adjusted with some delay in response to cost increases that built up over a longer period of time. For non-energy industrial goods, meanwhile, inflation came to a standstill. Looking at the year-on-year figure, the disinflation process slowed further. The inflation rate declined only slightly from 2.7% in the first quarter to 2.6% in the second quarter. The rate excluding energy and food likewise saw only a slight drop, falling from 3.4% to 3.2%. However, here, the decline was slowed by a base effect: the rate for May 2024 did not include the dampening effect on the previous year’s rate resulting from the introduction of the Deutschlandticket in May 2023.

Headline inflation actually rose slightly on the year in July, while the core rate remained unchanged. The latter remained at 3.3%. Headline inflation, however, rose slightly from 2.5% to 2.6%. After seasonal adjustment, consumer prices were up moderately in July on the month, with price inflation for services continuing to display above-average growth.

From today’s perspective, inflation rates are expected to temporarily return to somewhat higher levels towards the end of the year. The previously negative energy inflation rates will then turn positive. This is mainly due to the decline in energy prices in the final quarter of 2023. However, the currently depressed profit margins for refined petroleum products could also gradually creep up again. Core inflation is also likely to remain at an elevated level due to continued strong wage pressures.

Economic output could increase slightly in the third quarter of 2024. Private consumption is likely to grow, as are service providers. Consumer restraint appears to be more persistent than assumed, for example, in the June Forecast for Germany, with the saving ratio likely to rise again in the third quarter. Nevertheless, the favourable framework conditions should be increasingly reflected in growing household expenditure as disposable incomes rise significantly in price-adjusted terms. By contrast, the weakness in industry – and also in construction – is likely to continue. Foreign demand could remain frail amid the recent slowdown in global industrial activity. Moreover, industrial enterprises are navigating a difficult competitive environment. Exports and investment in machinery and equipment are therefore also likely to fall short of the expectations from the most recent Forecast for Germany. Overall, economic output is likely to expand only slightly. This will further delay the expected slow uptick in economic activity. However, as things stand today, a recession in the sense of a significant, broad-based and prolonged decline in economic output is not to be expected absent new negative shocks.

The general government deficit ratio is expected to decline moderately in 2024 and 2025. This is the result not of a restrictive austerity policy, but of the discontinuation of crisis assistance. On balance, the general government deficit ratio could range between 1½% and 2% of GDP in 2025, having stood at 2.4% in 2023. The same period will see around 1½% of GDP in burdens from temporary crisis assistance measures being taken out of the budget. The expiry of the energy price brakes in 2024 should do the most to relieve pressure on the government budget. The inflation compensation bonuses, which are exempt from tax and social security contributions, will subsequently expire in 2025 as well. On balance, these will be replaced by pay components subject to tax and social security contributions, which will generate additional revenue. In other areas, however, the budgets are likely to deteriorate. For example, the high inflation rates of recent years are still reflected in additional expenditure on the likes of administration and general costs or employee compensation. Pension expenditure will also rise significantly. Furthermore, the Federal Government announced new, in some cases deficit-increasing measures as part of its growth initiative.

The central government deficit is also likely to shrink. The Federal Government is budgeting for a total deficit of €113 billion for the core budget and off-budget entities in 2024. This is expected to decline to €87 billion in 2025. However, current expectations put the federal deficit in 2024 significantly below the planned figure. As things stand today, the Armed Forces Fund and Climate and Transformation Fund, in particular, will turn out more favourably. By contrast, deficits could be higher in 2025. For example, the more favourable developments in 2024 could open up more scope for deficits for 2025 (via higher reserves). In addition, the Federal Government’s draft budget estimates are fairly tight, and relatively high savings are to be achieved in the course of implementing the budget (a residuum spending cut).

In order to expand the scope of the debt brake, Deutsche Bahn is to receive additional equity instead of grants. This raises questions from an economic perspective and further distances the debt brake from the EU fiscal rules. Overall, Deutsche Bahn is to receive injections of €10½ billion in capital from central government’s core budget in 2025 for infrastructure investment. This is €4½ billion more than initially decided in July. Whether the switch will be adequate from an economic perspective depends on whether an appropriate return is to be expected on the equity capital. It would not make good sense if central government’s return turned out to be financed by central government itself via future burdens on the federal budget (e.g. via higher federal grants). In any case, it would be important to make it transparent how Deutsche Bahn intends to generate the return in the future with the new equity. This switch in how Deutsche Bahn is financed distances the debt brake further from the EU rules it is supposed to safeguard. The EU rules refer to the general government sector as defined in the national accounts. This includes the infrastructure component of Deutsche Bahn. Its investments therefore increase the national accounts deficit, irrespective of whether central government books financial transactions (such as capital injections) or grants in the core budget.

For sound public finances, it is important that the debt brake retains its binding effect. Reform that moderately increased a binding credit limit would be acceptable, however. In this context, the Bundesbank has proposed a moderate increase in the credit limit if the debt ratio is below 60%. A capped golden rule could be used to open up targeted, limited additional scope to borrow for net investment as well.

Germany remains tasked with rigorously tackling its economic policy challenges. The Federal Government’s growth initiative is addressing the right issues in many cases. Its goals include incentivising employment and investment, a reliable energy supply, and efficient, less bureaucratic public administration. However, some of the prospective measures do not match the goals, and in some cases more far-reaching steps are needed. For example, additional partial tax subsidies make tax law more complicated and more susceptible to creative tax practices, add red tape, and stress the country’s public finances. One strategy that works in the opposite direction would be to limit or eliminate tax exemptions and reductions combined with a lowering of general tax rates. One easily understood measure would be if employees no longer had to pay unemployment and pension insurance contributions after they reach the statutory retirement age. This is because, for these employees, the employer contribution represents a special levy in some cases under the existing system. In the interests of keeping older people in jobs, it would make sense to remove some of the incentives for early retirement. Even if the statutory retirement age after 2030 becomes linked to life expectancy, this would support a longer working life. These measures would alleviate the strong demographic pressure on pension finances and the federal budget.

The new EU fiscal rules are facing their first test: budgetary requirements must be sufficiently ambitious to promote sound public finances in the euro area. The stated objective of the rules is to lower high deficit and debt ratios. This is because sound public finances in the Member States are important for a stability-oriented euro area. They increase its crisis resilience and support the monetary policy of the Eurosystem. The onus continues to be on the European Commission and ECOFIN to ensure that fiscal requirements are sufficiently ambitious. The budget limits for the first planning periods will be agreed by the autumn.