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The Macro Brief – Getting Germany going
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German economists Stefan Schilbe and Anja Heimann consider whether a policy reboot – including a huge fiscal package – could help get Europe’s largest economy back on track.
Disclaimer: https://www.research.hsbc.com/R/101/9LXXCNH
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Transcript
Introduction to HSBC Global Viewpoint podcast series
00:00:01
Speaker
Welcome to HSBC Global Viewpoint, the podcast series that brings together business leaders and industry experts to explore the latest global insights, trends, and opportunities.
00:00:13
Speaker
Make sure you're subscribed to stay up to date with new episodes. Thanks for listening, and now onto today's show.
00:00:23
Speaker
This podcast was recorded for publication on the 8th of May 2025 by HSBC Global Research. All the disclosures and disclaimers associated with it must be viewed on the link attached media player. And don't forget to like and subscribe to The Macro Brief wherever you get your podcasts.
Germany's economic challenges: Tariffs and growth
00:00:40
Speaker
Hello, I'm P.S. Butler and welcome to the Macrobrief. On today's podcast, we're focusing on Europe's largest economy, Germany. Already suffering from weak growth momentum, the prospect of tariffs poses additional downside risks for an economy that relies heavily on exports.
00:00:56
Speaker
But with a new government and chancellor in place, could a policy reboot, including a fiscal package, help get the economy back on track? To find out, I'm joined from Dusseldorf by Stefan Schilber, Chief Economist for Germany. And here in London, we have German economist Anja Hyman.
00:01:12
Speaker
Stefan and Anja, welcome to the podcast. Stefan, if I can start with you, it's been just over 10 weeks since ah the election in Germany, and we finally have a grand coalition.
00:01:25
Speaker
They did say at the time that it would take ah take a bit of time ah to get that one sorted out. Is it fair to say that the options for a grand coalition were in fact limited and that it wasn't really plain sailing in order to pull that one together?
Political dynamics: CDU CSU coalition challenges
00:01:40
Speaker
Yeah, well, that's actually a fair description. One has to keep in mind that the CDU CSU was a clear election winner, having 28.5% of all votes, but actually only had one potential option as a coalition partner, of the so-called Social Democrats SPD,
00:01:58
Speaker
who had their worst result in history, but still, given that the CDU CSU has ruled out working together with the ultra right-wing AFD, they only had a chance to work together with the SPD to build a coalition.
00:02:13
Speaker
And this essentially meant that they had to make large concessions in the coalition negotiations. And furthermore, and this has become ah really important on last Tuesday, ah we learned that for the first time in history, the chancellor wasn't elected in the in the first round. So he missed the the necessary majority and ah was only re-elected in the second round. And this ah is clearly something which raises concerns about ah Merz's ability to pursue his political agenda. and And especially in case there are more controversial decisions to be made, this could become complicated over time.
00:02:55
Speaker
So to that point, Anja, in your report, ah you say that the coalition treaty falls short of expectations. So maybe explain why, but perhaps help me out because I was sort of trying to reconcile in my mind how this tied in with the fiscal package that was agreed before the coalition was even formed. How how did that work? So maybe remind us firstly on the fiscal package.
Fiscal strategies: Defense spending and infrastructure funds
00:03:17
Speaker
Sure. So essentially, there are three big parts to the fiscal package. The first one is that defence spending beyond 1% of GDP will be exempt from the deficit um under the current debt break.
00:03:30
Speaker
Now, this refers to the German fiscal rules, which are different from the EU fiscal rules. ah Second part of the fiscal package and now permits the 16 federal states to run small fiscal deficits, while previously they had to run balanced budgets.
00:03:47
Speaker
And then the third part of the package, and it's the one that is most important for the German growth outlook, is this 500 billion off-budget fund for infrastructure, which will be dispersed over 12 years.
00:03:59
Speaker
So with this package, essentially the way has been been paved, it has been written into the constitutions, these funds are there to be tapped, and it's now up to the new government to work out exactly what and how and like which projects to spend these funds on.
00:04:15
Speaker
Explain to me on the coalition treaty, what does that do? So the coalition treaty is separate from this fiscal package and it should more be seen as a sort of wish list or spelling out the goals and ambitions of this new government of the Conservatives and SPD. So one of the reasons why we were a little bit disappointed with the coalition treaty is that overall it falls a bit short of being the the broad economic policy reboot that Germany really needs to get its economy growing again.
00:04:43
Speaker
But there are some some really good reforms suggested in this treaty. For example, the new government aims to reduce the tax burden on private investments, first by having a special depreciation allowance for fixed investment up until 2027, which is then followed by gradual cuts to the corporation tax from 2028 onwards.
00:05:05
Speaker
There's also a pledge to reduce the cost of bureaucracy for firms by 25%. Now, this is very ambitious. And and while it is but very well would be a very welcome development, bureaucracy reduction on this scale has actually never occurred in German history. So we're a bit skeptical whether it will actually be implemented um to this to this extent.
Economic reforms: Feasibility and skepticism
00:05:26
Speaker
The coalition treaty also includes some labour market reforms um to increase people working, so tax incentives um to work overtime and to work beyond retirement age.
00:05:37
Speaker
There's also mention of stricter welfare ah eligibility criteria. But overall, these measures are really unlikely to yield a large increase in labour supply and certainly not large enough to offset the drag um that you get from an ageing workforce.
00:05:51
Speaker
And what is noticeably absent are any measures to boost female labor force participation. So a lot of good intentions, but some, as you say, some skepticism as to how achievable they are.
00:06:04
Speaker
And of course, the other area of skepticism which you raise is the overall challenge ah to all these reforms in terms of financing them, ah which on the face looks like a big challenge and and I guess could lead to disappointment further down the line.
00:06:19
Speaker
Yeah, so I think the the big caveat with all the measures mentioned in this coalition treaty is that they most of them are subject to funding availability. So no project is 100% certain, which is why I'd call the coalition treaty more of a wish list than concrete plan of reforms that will definitely get enacted.
00:06:38
Speaker
We should also remember that even with this extra ah borrowing scope that Germany has given and itself with the fiscal package in March, um the German Federal Ministry of Finance still assesses that the budget plan up to 2029 falls short by around 110 billion. So these are savings that still have to be found.
00:06:58
Speaker
And we also need to remember that Germany is currently still in a phase of provisional budget management and because the budget for this year, 2025, has not been approved um yet.
00:07:09
Speaker
So what this means is essentially the new government's scope to launch any major new projects is severely limited. it can really only secure the status quo.
00:07:20
Speaker
And this is one of the reasons why no forecasts. We also don't expect any any big boost from any fiscal activity this year. Stefan, if I can just turn to you, ah in my sort of experience of markets, you always have to look for unintended consequences.
Industrial production: Impact of tariff uncertainties
00:07:35
Speaker
And I guess the latest German industrial production figures, which are just out, are are a case in point. Yeah, that's actually true. The numbers were particularly strong in March, with industrial output rising by 3% orders, picking up strongly. So this is clearly a case of front-loading. So the rise in uncertainty as a consequence of ah potential U.S. tariffs has led to a very strong demand from abroad. You could also see that in today's data of nominal exports to the United States, which have risen to an all-time high in March.
00:08:10
Speaker
So ah we we saw front-loading effects in particular in the car industry and in the pharmaceutical sector, with pharmaceuticals rising by almost 20% in month-over-month terms, so very strong data.
00:08:24
Speaker
But apart from these very short-term effects, I'd like to remind you that, ah well, the broad sentiment among ah corporations in the manufacturing sector is still very much downbeat. So export expectations have indeed plunged after the US Liberation Day announcements.
00:08:43
Speaker
to the lowest levels since the global financial crisis, with the sole exception of two months in 2020 at the beginning of the lockdown during the pandemic. So corporations are not really buying into this kind of optimism and there's clearly ah very low visibility Political uncertainties have risen to all-time highs and this typically has consequences for business fixed investment spending because as capacity utilization rates are now extremely low at just 77.7%, so typically levels associated with a big crisis, this essentially means that corporations will be very, very cautious
00:09:26
Speaker
in, well, paying for capex.
Growth forecast: Germany and European manufacturing outlook
00:09:29
Speaker
So this could lead to a contraction in business fixed investment spending and also have some negative negative repercussions for overall economic growth in Germany, at least for the year 2025.
00:09:41
Speaker
Just to finish on that, Stefan, can you just remind us what your growth forecasts are? Yeah, actually, we are expecting a minus not 0.1% for 2025 as a consequence of this tariff developments, so which could weigh on exports, on business fixed investment, and could also have some negative repercussions for the labor market, and hence undermining consumer growth.
00:10:05
Speaker
But for the year 2026, we are a little bit more optimistic, ah particularly given that we think that the government's measures will finally get traction. And therefore, we expect 1% growth for 2026, a little bit less than we were assuming before the tariff announcements were made, but at least something which is above the long-term potential growth path.
00:10:32
Speaker
And and yeah let's zoom out and just get a bit of a European picture because you've just published the latest ah European macro tracker where we look at a variety of ah recent data.
00:10:44
Speaker
ah The manufacturing manufacturing picture consistent with Germany wasn't too bad, was it? Yeah, that's actually correct. So we had the final PMI print for April, which didn't show the feared immediate negative impact from the US trade policy.
00:11:00
Speaker
Instead, the manufacturing PMI rose to its highest level since August 2022 and is just hovering under neutral. And its output index remained above 50. So all that's certainly some some good news on the manufacturing side there.
00:11:15
Speaker
any Any other highlights from the data? that I mean, ah you know, the oil prices is falling sharply. In terms of monetary policy, what are we expecting? Well, the data so far really gives strong arguments to the doves and the hawks in the ECB and committee. So the the decisions over summer might be a bit tight.
00:11:37
Speaker
So the doves will probably point towards stable eurozone headline inflation, which was at 2.2 percent in April. and They'll also mention that there's a downward trend in the ECB wage tracker.
Monetary policy: ECB and U.S. interest rate trends
00:11:49
Speaker
On the other hand, the hogs will give some caution because they say growth has surprised to the upside in the first quarter and April's core inflation also surprised to the upside. It's sort of 2.7%.
00:12:01
Speaker
And even when we remove the effect of Easter, which is distorting price growth a little bit, services price growth momentum has certainly gone into reverse.
00:12:12
Speaker
Now, as you mentioned, oil prices have have fallen, other commodity prices as well. We've got the stronger euro We have some Chinese overcapacity. So overall, we still believe that a June cut by the ECB seems very likely.
00:12:26
Speaker
The outlook beyond might be a bit less clear than the market expects. um So the market is currently pricing in between two and three rate cuts till year end. That's just a bit excessive in our of view.
00:12:37
Speaker
Okay, just to finish, Stefan, can I come back to you and and defense spending? I mean, at the time, you know, what Germany did was seen as is really quite dramatic. I mean, now that a few weeks have sort of passed, how um has some realism come into how quickly this defense spending is going to rise and have an impact?
00:12:59
Speaker
Yeah, well, actually, this will take a lot of time before this money is really deployed. I'd like to give you one example. We had the 100 billion euro fund, which was created in July 2022. out of this billion fund as at the end of March So after 33 months, a little bit more than a fourth has been really paid out. So 25.9 billion.
00:13:27
Speaker
So this money will be deployed over the course of the time. But we should keep in mind that this is a very lengthy process and not something which will boost economic activity in the very short term.
00:13:40
Speaker
Okay, I think that's all we have time for. Anja and Stefan, thank you so much for joining us today. Thanks for having us.
00:13:50
Speaker
A couple of bits of central bank news. Yesterday, the Fed kept U.S. s policy rates steady at 4.25% to 4.5% for a third consecutive meeting. However, policymakers noted that uncertainty about the economic outlook has increased, with tariffs creating further complications.
00:14:08
Speaker
Looking ahead, U.S. economist Ryan Wang says that even with a likely deterioration in the future growth inflation trade-off, we only see 75 basis points of rate cuts through 2025 and 2026.
00:14:21
Speaker
and twenty twenty six And here in the U.K., the Bank of England delivered a fourth 25 basis point rate cut, taking bank rate to 4.25%. The move was anticipated by a senior UK economist, Liz Martins, who expects one rate cut per quarter until rates reach 3% in the middle of next year.
00:14:40
Speaker
Liz joined me in the studio recently, so if you'd like to hear more about the outlook for the UK, please take a listen to last week's episode. And finally, a reminder that our next Live Insights event is on Wednesday the 28th of May.
00:14:53
Speaker
I'll be chatting all things Asia with the co-hosts of our sister podcast, Under the Banyan Tree. That's Fred Newman, our chief Asia economist, and Harold van der Linde, head of Asia equity strategy.
00:15:04
Speaker
The event is open to everyone. You don't need to be an HSBC client, and it promises to be an interesting and entertaining conversation.
Upcoming event: HSBC Live Insights on Asian economics
00:15:11
Speaker
For details on how to sign up, email ossresearch at hsbc.com or head to LinkedIn and search hashtag HSBC Research.
00:15:24
Speaker
So that's all from us this week. Thanks for listening and we'll be back next week.
00:15:52
Speaker
Thank you for joining us at HSBC Global Viewpoint. We hope you enjoyed the discussion. Make sure you're subscribed to stay up to date with new episodes.