The current issue of the Bundesbank’s Monthly Report reports that German economic output was lower in the fourth quarter of 2022 than in the previous quarter. According to the Federal Statistical Office’s flash estimate, real gross domestic product (GDP) decreased by 0.2% in seasonally adjusted terms. High inflation eroded consumer purchasing power in Germany and sales in the retail sector dropped considerably in terms of quantity. Private consumption is therefore likely to have fallen markedly. High construction prices, reduced household purchasing power and increased financing costs led to lower demand for construction services and to weaker construction activity. However, according to the report, the overall decline in economic output was therefore milder than the Bundesbank’s experts had projected in December. “The situation in the energy markets eased markedly over the course of the quarter,” the economists wrote. “Moreover, output in the manufacturing sector remained more resilient than expected overall.”

No significant improvement in sight

However, economic output is likely to contract further in the first quarter of 2023. On the one hand, a gas shortage is no longer to be expected, and the electricity and gas price brakes are mitigating energy costs for households and enterprises. Tensions in the energy markets and uncertainty have eased considerably. This is likely to benefit primarily business investment, but also industrial production. On the other hand, inflation remains high, and industrial output and exports started the new year from a depressed level. “Although there could be a gradual pick-up over the remainder of the year, no major improvement is yet in sight,” according to the experts’ assessment of economic developments. On balance, from today’s perspective, Germany's economic output is likely to decline slightly on average in 2023,  the report states. However, the experts currently expect economic output to perform somewhat better than expected in the December projection.

Loss of purchasing power is making wage negotiations more difficult

With regard to the labour market, the experts' expectations from the December projections were exceeded. “The labour market improved again in the final quarter of 2022,” the current issue of the Monthly Report states. Employment rose slightly in the fourth quarter, after recording next to no growth in the third quarter. Unemployment remained stable at a low level. The outlook for the labour market has brightened in recent months, too, according to the report. Enterprises’ plans to expand their workforce in the short term are currently predominating. Although the fourth quarter of 2022 saw a continued moderate increase in negotiated wages, as older wage agreements from the period before high inflation still dominated, the most recent settlements were significantly higher. In addition to the rise in scheduled rates of pay, a growing number of agreements included inflation compensation bonuses. “The impact of high rates of inflation is already clearly discernible in the latest wage agreements. Marked second-round effects on prices are to be expected,” the experts write. Viewed in isolation, they will play a part in prolonging the period over which inflation remains well above the medium-term target of 2% for the euro area.

This year’s pay round for just under 11 million wage earners will predominantly feature negotiations in the services sectors. They will be shaped by high inflation and staff shortages on the one hand, and by the sluggish economy at present as well as uncertainties due to geopolitical risks on the other, according to the report. Furthermore, negotiations are being made more difficult by the restricted scope for wage distribution caused by the massive increase in energy prices.

Inflation rate is likely to decline yet still remain high

The German inflation rate as measured by the Harmonised Index of Consumer Prices (HICP) initially reached a new all-time high of 11.6% in October. By the end of the year, it then fell to 9.6%, mainly as a result of the government’s assumption of advance payments on gas and district heating (December immediate assistance). According to estimates, it declined further to 9.2% in January. According to the report, this decline was surprising, as the dampening effect of emergency aid in December was no longer present. The shares of individual goods and services in the HICP may have shifted more than usual and may have contributed to this change in the HICP rate, the experts write. The respective shares of different goods and services in the basket of goods used to measure price changes are adjusted at the beginning of each new year. This year, however, several factors may have led to a more pronounced shift in shares, including the rebasing of the national consumer price index (CPI) to a new base year. In the Bundesbank’s assessment, this rebasing is also impacting the HICP. Although the inflation rate is likely to decline markedly in the coming months, underlying price pressures are likely to weaken only tentatively from their high level.