World Economy

IMF Says May Lower German Growth Outlook

IMF Says May Lower  German Growth OutlookIMF Says May Lower  German Growth Outlook

The International Monetary Fund is likely to lower its growth forecast for the German economy as a result of Britain’s decision to leave the European Union, Enrica Detragiache, the assistant director of the IMF’s European department, said.

Britain is an important trade partner for Germany, and significant changes in the economic relationship between the two will have repercussions for Germany, IMF report said.

The growth momentum has remained steady as strong domestic demand has offset weak foreign demand. Private consumption growth has been supported by the persistently strong labor market and lower energy prices, while public consumption and investment have also been buoyant.

Core inflation has been low and stable around 1%. The current account surplus has continued to widen significantly, reaching 8.5% of GDP in 2015, reflecting lower commodity prices and currency effects. The fiscal stance was neutral last year.

Credit growth, long subdued, has picked up, while housing prices have kept trending up in the context of a slow supply response to surging housing demand. The banking sector faces multiple challenges, which translate into low profitability.

Negative interest rates erode profits from retail banking, the aggregate cost-to-income ratio is high in international comparison, while technological changes and the new regulatory environment—which is still being implemented—require business model adaptation. Low interest rates, if protracted, would also weaken life insurers’ ability to meet guaranteed commitments.

Looking forward, domestic demand is expected to keep underpinning the moderate growth momentum. A sizable fiscal expansion, the recent further ECB monetary stimulus, and still supportive energy prices should continue to offset the weakness in some key trading partners. GDP is projected to grow by 1.7% this year and 1.5% next year. A small positive output gap should open up which, together with the effects of recent ECB policy actions, should very gradually push up core and headline inflation towards 2%.

However, this forecast does not yet reflect the economic impact of the UK referendum decision in favor of leaving the European Union. In addition, growth over the medium term is expected to decline against the backdrop of a still uncertain global outlook, a population aging fast, and slow progress on structural reforms.

  Underpinning Growth

Executive directors welcomed the increased contribution to growth from domestic demand, supported by lower energy prices, rising real wages, declining unemployment, and accommodative fiscal and monetary policies. These developments will continue to underpin growth in the period ahead.

Directors noted that risks to the outlook are tilted to the downside, including weaker growth in Germany’s trading partners and heightened uncertainty following the outcome of the referendum on the UK membership in the European Union. Meanwhile, the large current account surplus persists, and an aging population and refugee inflows continue to pose challenges.

They welcomed the authorities’ ongoing efforts to enhance the overall efficiency of public investment and plans to address administrative and regulatory constraints to investment. Directors also commended the German government for shouldering the burden of absorbing a large inflow of refugees.

  Call for Faster Progress

Directors underscored that faster progress on structural reforms is essential for boosting medium term growth in a rapidly aging society. They called for well targeted measures to increase labor supply by promoting labor force participation of women, older workers, and immigrants; and reforming taxation, the pension system, and health insurance contributions.

Directors also encouraged decisive steps to enhance competition and productivity in the services sector. They welcomed recent actions to ease supply constraints in the housing sector.

Directors observed that the overall banking sector remains strong, resilient, and well capitalized. Nevertheless, given prolonged low interest rates, high operating costs, and technological and regulatory changes, it is important that banks accelerate their efforts to adjust to these challenges and improve risk management.

Directors recommended that the authorities monitor the insurance sector closely, require action plans from troubled firms, and keep safety nets under review.