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Bundesbank expects recession in final quarter of 2022 and first quarter of 2023

Contrary to expectations, German economic activity expanded in the third quarter of 2022, the Bundesbank writes in its current Monthly Report. Despite high inflation and uncertainty about the future supply of energy, real gross domestic product (GDP) grew by 0.3% on the quarter after seasonal adjustment, according to the Federal Statistical Office’s flash estimate. “It thus exceeded its pre-pandemic level for the first time,” the report states.

The Bundesbank’s experts believe that downward forces will clearly predominate in the coming months, though, with the inflation rate being likely to remain high and the situation in the energy markets tense. In addition, the slowdown in global economic activity is expected to have an impact on the export-driven industrial sector, despite full order books and receding supply bottlenecks in industry mitigating the lower demand somewhat. They note that high inflation is dampening private consumption and thus activity in the consumer-related services sectors. Moreover, the catch-up effects following the lifting of most coronavirus mitigation measures will dissipate, and the pandemic-related rise in government final consumption expenditure will gradually return to normal. “Overall, this means that although economic activity was higher than anticipated in the third quarter, a recession is still to be expected in the German economy in the final quarter of 2022 and the first quarter of 2023,” the experts conclude. The scale of the recession is extremely uncertain, though. As things currently stand, a gas shortage can probably be avoided, but the decline in real GDP would be more pronounced in the event of one arising.

Only marginal increase in unemployment

The experts write that the labour market is currently caught between opposing forces. On the one hand, many sectors are still experiencing understaffing, a high number of vacancies and long recruitment periods. On the other hand, demand for labour is declining, especially in the areas hit especially hard by cost increases. According to the Federal Employment Agency, 2.52 million persons were registered as unemployed in October; the unemployment rate stood at 5.5%. Despite the steep increase in the general statutory minimum wage to €12 per hour in October, unemployment was up only marginally in October.

In view of high inflation, trade unions are calling for exceptionally large wage increases in the ongoing negotiations. According to the Bundesbank, however, these demands are not expected to lead to actual wage settlements of the same magnitude. “Although this does not suggest that wages are accelerating inflation, the risk of second-round effects has become greater,” the experts explain, adding that these effects would increase the risk of the euro area inflation rate remaining well above the medium-term target of 2% for a longer period of time.

Double-digit inflation since September

In seasonally adjusted terms, the exceptionally strong rise in consumer prices as measured by the Harmonised Index of Consumer Prices (HICP) continued into the third quarter, the Bundesbank writes. The already very large increases in food prices in the previous quarters intensified once again. According to the experts, consumer energy prices also continued to rise markedly despite factors intended to bring relief, such as doing away with the renewable energy levy (EEG levy), the fuel rebate and falling crude oil prices. Inflation in Germany hit double digits (10.9%) in September for the first time since the early 1950s. In October, prices again saw very sharp growth of 1.1% on the month in seasonally adjusted terms. Annual headline inflation stood at 11.6%. Excluding energy and food, it was up from 4.7% to 5.1% at the end of the period under review.

Very high inflation likely to persist into early 2023

“Double-digit inflation could even persist into the new year,” the report states. There is still strong cost pressure at earlier input stages, especially in the case of industrial goods. Prices for crude oil and other energy sources were down at the end of the period under review but are still at a very high level, the experts write, and the pass-through of the previous rise in commodity prices to consumer rates for electricity and gas is still ongoing.

It is difficult to assess what impact the announced gas price brake will have on the inflation rate, however. In a first stage, the government will pay consumers’ gas bills in December. The second stage of the gas price brake, under which 80% of households’ basic gas consumption from the previous year would be capped at a guaranteed 12 ct/kWh, could potentially dampen the inflation rate by almost 1 percentage point. However, the experts note that there is a lack of clarity as to how either stage will be reflected in the official price measurement, and uncertainty regarding how gas prices would develop in the absence of a gas price brake is likewise high. This applies in equal measure to the electricity price brake envisaged for the start of 2023.