German economy in stormy waters as government slashes forecast

The German government expects the economy to grow 0.2% this year, far less than a previously forecast 1.3%, as weak global demand, geopolitical uncertainty and persistently high inflation dent hopes for a swift rebound.

The revised forecast was approved by the cabinet on Wednesday as part of the government’s annual economic report, government sources said. Economy Minister Robert Habeck is scheduled to give details later in the day.

Europe’s largest economy shrank by 0.3% in 2023 and is broadly expected to enter another technical recession in the first quarter of this year.

“The German economy continues to find itself in difficult waters at the beginning of the year,” said a draft of the report seen by Reuters.

It listed high inflation and a resulting loss of purchasing power among the challenges, as well as geopolitical crises and interest rate hikes.

Germany’s economic advisers plan to follow the federal government’s lead and reduce their forecast for economic growth in 2024, adviser Ulrike Malmendier told Reuters in an interview.

“I think we will definitely be going in the same direction... that is what our numbers are indicating,” Malmendier said.

The November forecast of the council of advisers to the government estimated growth would hit just 0.7% in 2024. The next official update is due in mid-May.

The gloomy outlook for Germany comes amid concerns over its status as an industry location, as the government tries to reconcile its strict fiscal rules with the need to attract investment and help fund a costly green transition.

The draft government report points to a “normalisation” of fiscal policy in 2024, after a constitutional court ruling forced the coalition to make painful cuts in its 2024 budget.

The government is also expected to forecast an easing in inflation on Wednesday, from 5.9% in 2023 to 2.8% this year.

Eurozone bond yields: Euro zone bond yields were steady on Wednesday before the release of minutes from the Federal Reserve’s January meeting, which should provide hints at the future policy path as markets rein in bets for spring rate cuts.

Germany’s 10-year bund yield, the benchmark for the euro area, was up less than one basis point (bp) at 2.376%, just below Friday’s 2-1/2 month high of 2.422%. The policy-sensitive two-year yield was unchanged at 2.797%.

“The highlight of the day will be the Fed minutes,” said Sebastian Grupp, fixed income analyst at DZ Bank. “Otherwise, there are not big drivers today and we could see sideways movement in Europe,” Grupp added, highlighting that the minutes will not be released until 1900 GMT.

The Fed left its target range for the Fed funds rate unchanged at 5.25%-5.5% at its January meeting, while dropping its bias to tighten policy.

A slight majority of economists surveyed by Reuters expect the Fed to begin cutting interest rates at its June gathering.

Meanwhile, a slight moderation in negotiated wages in the euro zone in the fourth quarter, announced on Tuesday, would have been welcomed by policymakers, but analysts said it would be unlikely to move the needle in terms of rate cut timing.

“It’s a good sign that wage growth has come down,” said DZ Bank’s Grupp. “But 40% of observed wages will be negotiated in the next three months. The European Central Bank will want to wait for that data to come in.”

Money market traders were now pricing in the first quarter-point interest rate cut from the ECB in June, according to LSEG data. A March rate cut had been baked into expectations at the start of the year.

Investors were also expecting about 106 bps of easing this year, or around four 25 bp moves, having priced as much as 150 bps of cuts at the end of 2023.

Despite a repricing of rate expectations for the ECB, Italian bonds, or BTPs, have outperformed German peers this year.

The spread between Italian and German 10-year yields , a gauge of risk premium, traded close to its tightest level since March 2022 at 147 bps.

UniCredit analysts said the performance of Italian bonds has been “remarkable” given markets have reined in rate cut expectations and there’s been heavy supply, yet they do not expect the spread to widen from here.