Germany’s economy is facing a host of risks—from high real estate prices to weak banks—but investors may be ignoring vulnerabilities given the country’s eight-year economic run, the Bundesbank said on Wednesday.
Germany, the eurozone’s biggest economy, has been the engine of the bloc’s remarkable recovery, with indicators pointing to an ever-broader expansion helped by extraordinary central bank stimulus, Reuters reported.
“There is a danger that low interest rates and the favorable economic conditions in Germany might cause market participants to underestimate risks,” the German central bank said in a regular stability report.
“Risks have built up, in particular, during the prolonged period of low interest rates—the valuations of many investments are very high, and the share of low-interest investments on the balance sheets of banks and insurers has risen steadily.”
The bank sector is currently strong and able to cope with risks but low interest rates threaten their long term profitability, raising the incentive for them to take on more risk in hope of higher returns, the Bundesbank added.
Residential property prices may be 15 to 30% overvalued and while risks stemming from housing loans still appear to be limited, a reversal in house prices could have a “huge” impact on banks, it said.
German banks are among the least efficient in Europe, with their return on assets among the lowest in the bloc and their cost to income ratio at 74.9%, the highest in the eurozone.
“This low level of profitability could increase the incentive to take on more risk in order to generate higher returns,” the report said, noting that an unexpectedly long period of low interest rates will continue to put pressure on small and medium-sized banks and life insurers in particular.
Gov't Should Pursue Reforms
Eurozone’s largest and most powerful economy is in danger of overheating, Germany’s influential Council of Economic Experts has also warned, calling on the country’s next government to pursue reforms to ensure that the boom does not end in disaster.
The council, composed of five top economists who present an annual report to the German parliament, warned that with growth above trend and interest rates low, risks to the country’s financial system would rise and conditions threatened to create a bubble in property prices.
“We’re in this low interest environment that has been going on for a long time, and so there is good reason for these high prices (for property),” Isabel Schnabel, a member of the council, said in Berlin on Wednesday. “But when the interest rates rise again these prices could go very quickly in the opposite direction.”
The council said in its annual report, which it presents to the parliament, that the economy would expand by 2.2% next year following several years of high growth. The council believes Germany’s long-term potential growth rate—the degree to which the economy can expand without producing distortions in inflation and markets—is 1.4%. Inflation would, at 1.8%, remain low.
It came up with an agenda of reforms to take advantage of strong growth—many of which are in line with measures called for by the Free Democratic Party, one of the parties that is expected to form part of Germany’s next ruling coalition. The FDP is in talks with Angela Merkel’s center-right CDU, its Bavarian sister party the CSU, and the Green Party on forming a new government.
Adjustments that the council has called for include a revamp of the German income tax code to allow increases in inflation to be taken into account, and more training to equip workers to better deal with digitalization.
Report’s recommendations on European economic reform also echo those of the FDP. The council rejected the idea of creating a much larger European Stability Mechanism to provide support for weaker member states, saying it should under no circumstance become a transfer union.
The council also accused the European Central Bank of being too opaque and called on it to end its mass bond buying scheme sooner than it intends to. The ECB plans to buy €30 billion of bonds a month from January to September next year as part of its €2.6 trillion quantitative easing program.
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