The global economy remained on a moderate growth path at the beginning of the year, and the regional disparities among the advanced economies narrowed somewhat. Economic output in the euro area, which had continued to decline in the previous quarter, started to rise markedly again. By contrast, the previously strong economic growth in the United States weakened. China’s economic activity gained in strength, partly as a result of economic policy support measures. 

Survey results point to global economic activity increasingly gathering pace in the spring. According to surveys of purchasing managers, business conditions around the world have improved markedly in recent months. Industrial activity in the emerging market economies continued to gather momentum. By contrast, industrial output remained weak in the advanced economies, where the services sector was the main contributor to the improved sentiment. 

Numerous commodity prices have picked up again somewhat in recent months. Oil prices, in particular, went up significantly at times. The improved demand outlook and renewed production cutbacks by some OPEC countries are likely to have played a key role here. In addition, crude oil prices were influenced by the geopolitical conflict in the Middle East. Many other commodity prices have also risen again somewhat of late. 

The disinflation process has recently slowed down. Consumer price inflation in the group of advanced economies has hardly eased at all since January. At 3.0% in April, the annual rate was only slightly below the level recorded for January, not least because of higher energy prices. Meanwhile, the core rate (from which energy and food prices are stripped out) fell somewhat more sharply, but remained high at 3.4%. The robust wage growth in many places and the recent pick-up in demand could make the disinflation process more difficult going forward.

The idea that interest rates would be cut early and quickly still prevailed in international financial markets at the beginning of the year. Market participants gradually abandoned this idea on account of improved economic data and stalling disinflation in the United States in particular. At the beginning of the year, market participants initially expected that interest rate cuts would already begin in the spring. Due to stalling disinflation and positive economic signals, central banks, including the US Federal Reserve and the Eurosystem, stressed the data dependence of their approach. For the United States in particular, these factors have shifted interest rate cut expectations for the current year into the future. At present, market players consider an initial US policy rate cut likely only after the summer. These impulses from the United States have also spilled over into the euro area, for which market players likewise lowered their expectations of rapid interest rate cuts. Market participants continued to consider an initial key interest rate cut in June likely. However, they assessed the future trajectory of policy rates as more uncertain. In this environment, long-run nominal and real interest rates rose in both currency areas, with the relative interest rate advantage of the United States increasing.

Risky assets benefited from a positive boost to the economy and investors’ rising risk appetite. In the European corporate bond markets, for example, yield spreads over safe federal bonds (Bunds) narrowed markedly. In addition, the international equity markets were boosted by enterprises’ stable earnings performance. In the reporting period, foreign exchange markets were also shaped by strengthening expectations that a US interest rate reversal would now take place at a later date. The persistent weakness in the yen is therefore likely to be because monetary policy in Japan remains much more accommodative than in the United States and the euro area. 

At its monetary policy meetings in March and April 2024, the Governing Council of the ECB left the three key interest rates unchanged. In the new March ECB staff projections, inflation was revised down compared with the December projections, in particular for 2024. After further data were received confirming the ECB Governing Council’s assessment of the medium-term inflation outlook, the Governing Council adjusted its communication on key interest rates in April. In accordance with this new communication, it would be appropriate to reduce the current level of monetary policy restriction if the Governing Council’s updated assessment of the inflation outlook, the dynamics of underlying inflation and the strength of monetary policy transmission were to further increase its confidence that inflation is converging to the target in a sustained manner. However, the Governing Council also stressed that it will continue to follow a meeting-by-meeting approach and that it is not pre-committing to a particular rate path.

In March, the Governing Council additionally announced changes to the operational framework for steering short-term interest rates. The review announced in December 2022 was intended to ensure that the operational framework remains appropriate as the Eurosystem balance sheet normalises. The Governing Council therefore agreed on key principles and parameters that will guide monetary policy implementation and the provision of central bank liquidity. In particular, the spread between the interest rate on the main refinancing operations and the deposit facility rate will be reduced to 15 basis points from the current spread of 50 basis points as of September 2024.

The broad monetary aggregate M3 saw only moderate growth in the first quarter of 2024. M3 developments reflected strong foreign demand for euro area securities on the one hand, and a further adjustment in demand for money on the other. In the reporting quarter, households and enterprises continued to shift their assets from overnight deposits in favour of short-term time deposits, albeit on a declining trend. At the same time, they showed stronger demand for longer-term bank debt securities that offered superior yields to short-term bank deposits. On the counterpart side, net purchases of euro area government bonds by non-residents and the current account surpluses buoyed monetary growth in the euro area. Bank loans to the private non-financial sector increased only marginally on balance. According to the Bank Lending Survey (BLS), this was due to the continued subdued loan demand, while credit standards were barely tightened further or were even eased in some cases. 

German economic output rose somewhat in the first quarter of 2024. According to the Federal Statistical Office‘s flash estimate, seasonally adjusted real gross domestic product (GDP) rose by 0.2% on the previous quarter. In the last quarter of 2023, it had fallen sharply. Growth was recorded in the construction sector, in particular, but also in industry and probably in services as well in the first quarter of 2024. This was partly due to favourable weather conditions for construction activity. The previous quarter had seen weather detrimental to construction, by contrast, producing the major swing now seen in construction. In energy-intensive industry, the negative trend did not persist and production picked up substantially. Moreover, the sickness rate was not quite as high as in the previous quarter, which is also likely to have bolstered economic output. In addition, the remaining backlog of orders enabled production to increase in construction but above all in industry, as demand remains weak in both sectors. There was a sharp contraction in new orders for industry from both Germany and abroad. This is a reflection of the fact that global trade remained subdued and increased financing costs off the back of the interest rate reversal as well as greater economic policy uncertainty dampened domestic investment. High financing costs also weighed on new orders in the main construction sector. Private consumers remained unsettled, meaning that their consumption was still sluggish even though their income situation is likely to have improved significantly thanks to a stable labour market and a renewed rise in real wages. The fact that the services sector probably expanded in spite of this is due to growth in sectors more related to industry and business.

In Germany, lending business with non-financial corporations moved sideways on balance in the first quarter. This was due, on the one hand, to the fact that the rise in financing costs, coupled with the uncertain economic prospects, reduced loan demand for many enterprises. On the other hand, credit standards also continued to suppress lending. Lending business with domestic households grew slightly again for the first time following three weak quarters. The main driver here was loans for house purchase, which saw considerably stronger growth than in the preceding three quarters. At the same time, consumer credit and other lending to households continued to decline at unabated pace.

The German labour market was very stable in the first quarter of 2024, too. Employment growth continued on a muted positive track. Over the course of 2023, enterprises largely retained their workforces despite the economic slowdown and staff levels were even increased in many services sectors. However, the increase in the first quarter of 2024 was not strong enough to fully absorb the number of active workers, which is rising as a result of immigration in particular. Registered unemployment therefore increased as well, though likewise by only a marginal amount. Leading indicators suggest that this pattern is unlikely to change markedly over the next few months. Even if economic developments turn more positive, it is likely that greater use will be made of current staff in the first instance. The currently depressed level of working hours would then recover.

Wages rose steeply in the first quarter of 2024. In the first quarter, negotiated wages went up by 6.2% on the year. Large social contribution-exempt inflation compensation bonuses also played a role here. 

Actual earnings are also likely to have risen sharply once again. Recent wage agreements and trade unions’ wage demands, which are still high by historical standards, also point to continued high wage growth. Although inflation has declined considerably since its peak in autumn 2022, unions remain aware of the accumulated real wage losses of the past three years and are aiming for a sustained increase in real wages. In addition, no more temporary, social contribution-exempt inflation compensation bonuses will be awarded at the end of 2024. Permanent wage hikes are now therefore increasingly taking greater prominence. 

Price pressures edged up again slightly in the first quarter. In the first quarter of 2024, consumer prices (HICP) rose by a seasonally adjusted 0.8% on the quarter, compared with 0.2% in the final quarter of 2023. The strong and broad-based price inflation for services was the main contributing factor. Looking at the year-on-year figure, the disinflation process continued in the first quarter of 2024, but at a much more moderate pace than before. There was thus only a comparatively small fall in the inflation rate from 3.0% in the previous quarter to 2.7%. At 3.4%, core inflation (HICP excluding energy and food) remained markedly above the headline rate. 

Prices also rose somewhat more sharply in April. After seasonal adjustment, the HICP rate increased by 0.4%, compared with +0.2% in March. This was driven by a substantial rise in energy prices, which had fallen in the previous month. One factor here was the expiry of the temporary reduction in the VAT rate on gas and district heating in April. Looking at the year-on-year figures, the inflation rate rose slightly on balance to 2.4%. By contrast, core inflation fell distinctly to 2.9%.

Inflation is expected to rise again in May and could fluctuate at a slightly higher level over the next few months. This is predominantly due to base effects stemming from local public transport, with average ticket prices down sharply owing to the introduction of the “Deutschlandticket” in May 2023. In addition, looking at the year-on-year figures, energy prices are likely to rise again in May and later in the year owing to base effects. Risks to the underlying disinflation process persist overall. Wage growth has exceeded expectations of late, which could mean that the still high price pressure in services will persist for longer.

Economic output is expected to rise again slightly in the second quarter of 2024. Service providers are likely to continue their recovery. ifo Institute survey results for consumer-related services sectors indicate that this recovery could even broaden and intensify at the first signs of any impetus from private consumption. This should see rising real disposable household income prevail over consumer uncertainty. Further gains in purchasing power are likely as the labour market is expected to remain robust and wages continue to rise steeply. In industry, energy-intensive sectors could recover moderately. However, for a sustainable recovery in industry, there would also have to be a broad-based improvement in new orders. This has not yet happened. The brighter business expectations in the manufacturing sector will therefore probably only provide perceptibly more momentum to output from the second half of the year onwards. Demand is still very weak in construction as well, and there are no signs of a major rebound yet. The normalisation following the weather effects in the preceding quarters is also likely to have a dampening effect in the second quarter. By contrast, a further decline in sickness levels could bolster economic output again. Overall, the underlying cyclical trend is probably gradually gathering momentum slightly. 

German public finances are likely to continue to improve this year and next, with the decisive factor being the discontinuation of crisis assistance. The deficit ratio could decline to under 2% this year, having stood at 2.5% in 2023. The expiry of the energy price brakes will actually provide slightly more budgetary relief than it did in the previous year. However, this is counterbalanced by strong growth in several expenditure items, first and foremost, the Armed Forces Fund and the Climate Fund. The deficit ratio looks set to shrink further next year. This can mainly be explained by additional revenue as inflation compensation bonuses will again be subject to tax and social security contributions. Without this, the deficit ratio would probably more likely move sideways. 

The debt ratio is also likely to decline, but this will be partially offset by increasing obligations arising from EU debt. The national debt ratio stood at 63.6% at the end of 2023. However, this takes no account of the share of EU debt that Germany will ultimately have to shoulder. If this is factored into the debt ratio, it would have stood at an estimated 65.4%. This ratio will fall less sharply than the national ratio, because EU debt will continue to rise significantly until 2026. 

Overall, public finances are unlikely to have an excessively restrictive effect on economic developments this year or next. The concerns expressed in some quarters therefore seem exaggerated, and an economic upturn can be expected. In 2024, the general government deficit will decline in net terms purely due to the discontinuation of the energy price brakes. This should have only a minimal impact on economic growth, partly because upstream gas and electricity prices in 2024 are set to be lower again than in 2023. Looking ahead to the coming year, it is often overlooked that central government and its off-budget special funds still have broad leeway for deficits. These include deficits for cyclical burdens and financial transactions, the remaining reserves and the Armed Forces Fund’s leeway for deficits. 

Federal budget and Climate Fund could develop more favourably in 2024 than planned. As a result, they could still have significant reserves going into 2025. The deficit in 2025 could thus be higher without violating the credit limit under the debt brake. Budget negotiations are currently difficult. However, this appears to be because considerably more funds have been requested as compared with the framework set out by the Ministry of Finance. In any case, central government’s scope for deficits, including its off-budget entities, is unlikely to be much lower than the deficit currently expected for 2024. 

Further discussions are taking place with regard to the debt brake. The Bundesbank deems a stability-oriented reform to be worthy of consideration. As long as the debt brake applies consistently, it will be well able to safeguard sound government finances, even if the credit limit is moderately higher. Specifically, a higher credit limit seems acceptable given a debt ratio of below 60%. If the national rules then ensure that the structural general government deficit ratio stays below 1½%, this should, generally speaking, also fulfil the new EU requirements. Any additional fiscal leeway from such a reform could, moreover, be reserved for particularly important tasks: a capped golden rule, as outlined by the Bundesbank, would allow additional leeway to be created in a more targeted manner, for net government investment, say. As an alternative to adjusting the net credit limit, Germany’s Basic Law (Grundgesetz) allows for a special fund with its own credit limit in some instances. A special fund of this nature could be designed in such a way that it expands the deficit scope in a comparable manner, meaning that it would not run counter to the basic considerations discussed above.