Snapshot of German Economy - Growth Remains Modest

UNCLAS SECTION 01 OF 02 BERLIN 001950

SIPDIS

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SIPDIS

DEPT OF LABOR FOR ILAB - BILL BRUMFIELD
STATE FOR EB, EUR/AGS, AND EUR/RPE

E.O. 12958: N/A
TAGS: ECON EFIN ELAB PREL GM
SUBJECT: Snapshot of German Economy - Growth Remains Modest


SENSITIVE BUT UNCLASSIFIED. NOT FOR INTERNET DISTRIBUTION.


1. (SBU) Summary: Germany remains on track for a mild economic
revival this year, with 0.4% GDP growth in the first quarter of 2006
and expectations of 1.8% for the year as a whole. Recent
unemployment figures were better than expected after the
disappointing start earlier in the year. Business confidence
indexes remain strong, and first-quarter growth, unlike in past
quarters, saw a significant boost due to increased investment in
capital goods, as opposed to just exports. However, the coalition's
recently agreed health reform plans seem likely to raise
payroll-based contributions to the state health system, thereby
missing the key reform goal of bringing down non-wage labor costs.
In late June, business leaders complained to the Chancellor and
other ministers that the pace of reform was too slow. Business
leaders have also noted that strong performance overseas does not
mean leading German firms are doing well in markets at home. End
Summary.

MIXED PICTURE


2. (U) After a stagnant final quarter of 2005, Germany's economy
saw modest growth in the first quarter of 2006, with 0.4% growth
(seasonally, calendar and price adjusted),slightly below the
expected 0.5%. Strong export-sector performance helped stimulate
increased confidence among consumers and those planning domestic
plant investments. German manufactured goods exports rose 4.5% in
the first quarter over the record numbers Germany saw last year. On
the domestic side, capital goods investment was up 2.2% and
accounted for a significant portion of the rise in GDP. Producers
of capital and intermediary goods, especially the machine tool and
chemical industries, enjoyed a backlog of orders as firms worldwide
looked to expanding their production capacities. Private household
consumption improved somewhat rising 0.6% in the first quarter after
stagnating in 2005.


3. (U) The FIFA Soccer Word Cup too seems to have had a positive
effect on certain industries with increased sales in consumer
electronics, merchandise, and travel. However, a real turnaround
for the chronically weak German retail sector remained elusive, even
with longer shopping hours - including on Sunday - for the duration
of the tournament. In the face of continued high unemployment and
stagnant wage growth, the World Cup did, however, create an
estimated 50,000 to 60,000 temporary jobs. A more lasting effect
may be a boost in tourism to Germany, a sector that already employs
more than 2.8 million, due to the positive coverage generated by the
event.


4. (U) Business confidence indicators are again positive,
recovering in June after the drop some saw in May. The IfO Index,
based on a poll of 7000 companies, fell in May for the first time in
twelve months as business people's outlook for the coming six months
slightly clouded. Business analysts were therefore surprised when
in June renewed optimism about the current situation and the
business outlook pushed the index to a 15-year high. The ZEW
Indicator of Economic Sentiment too fell 12.2 points for May,
finishing only slightly above its historical average at 37.8 points.
Analysts cite uncertainty about further interest rate hikes (after
the European Central Bank announced a rate increase of 0.25 basis
points to 2.75% June 8),high oil prices, and slower global growth
as causes for concerns for German business leaders.

JOB FIGURES -- THE FOCUS FOR GERMAN POLITICIANS AND REPORTERS


5. (U) The number of unemployed in the total German workforce
remained high at 4.7 million during the first quarter; the
unemployment rate was 11.3 percent in January-February and 11.4
percent in March (all figures seasonally adjusted). The colder than
usual winter delayed seasonal improvement until the second quarter,
but then the figures were better than expected: in April 4.691
million unemployed (11.3 percent),in May 4.596 million (11.0
percent),and in June 4.542 million (10.9 percent).


6. (U) Surveys indicate most German firms plan to keep their
workforce at current levels, although the wholesale sector plans a
slight increase in hires. In addition, wages remained stagnant in
the first quarter (year-on-year),after falling 0.6% during the four
preceding quarters, according to Economic Ministry officials. They
expect projected inflation of 1.3% to offset a net 1.4% rise in

2006.


7. (U) In spite of continued wage stagnation, big-ticket purchases
in advance of the January 1 VAT increase will likely boost
consumption figures. The Bundesbank expects these advance purchases

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to add 0.25% to GDP growth this year. Economic Ministry officials
expect the effect of the VAT hike to shave off a solid 1% of next
year's growth, which could thereby stifle the domestic recovery.
Finance Minister Steinbrueck called the VAT hike the "least bad of
the options available to the Federal government" to help cover
pension costs and help get the deficit to GDP ratio below the three
percent Maastricht ceiling for the first time in five years.

Impatience OVER THE PACE OF Reforms


8. (SBU) While Chancellor Merkel can take much of the credit for
Germans' increased optimism, businesspeople have begun criticizing
the lack of progress on economic reforms the CDU/CSU-SPD Grand
Coalition promised when it took office in November. Business
leaders in the Federation of German Industry (BDI),Germany's
leading business association, reportedly told Merkel and other
ministers June 21 that their patience with the lack of progress on
reforms was exhausted. BDI recently said in a statement that
"doubts about the problem-solving ability of this government are
growing." German business leaders have also emphasized in the
meetings with Embassy officials that, although they are doing well
in world markets, the situation at home remains difficult.


9. (SBU) For example, on the health reform plans the coalition
agreed upon in early July, the parties openly squabbled about how
best to move financing for the system away from payroll-based
contributions and thereby reduce non-wage labor costs. The SPD
proposed large income tax increases to shore up the system's
financing while avoiding benefit cuts. But when Merkel indicated
she might accept these tax increases, some state-level CDU leaders
rebelled. The end result is a watered-down reform the government
will send to the legislature that actually increases non-wage labor
costs and postpones dealing with the long-term future of the health
care system.
TIMKEN JR.