02 February 2004

EZA 577 : Germany - Economy; Sector Outlook

Impact of global recovery feeding through to Germany but domestic demand low, euro strength oppresses
Germany is leveraged to take advantage of the global recovery for now but 2004 likely to be a year of living dangerously with a stronger euro. There is no guarantee of successful transition to domestic-demand led growth. Pressure on the ECB to ease policy further will likely grow from Germany, especially as the stronger euro will begin to squeeze export-led recovery. Five points should be noted: (i) Recent sectoral evidence shows German capital goods manufacturing are good leveraged plays on a global recovery; (ii) only modest impact to date of stronger euro, but this is changing – corporate surveys suggest $1.30/Eu may be key competitiveness level; (iii) structural problems in retail sector and high cost base suggest 2004 will again be difficult, with further pressure on margins, barring a surge in private consumption; (iv) weak employment and consumer caution suggest a surge in private consumption is unlikely, despite Eu8bn in tax cuts. Administered price increases will squeeze real income growth and hold headline inflation near 1% in H1; (v) disinflationary environment will also benefit bonds and stocks of companies with a low cost base at the expense of retailers and exporters of price-sensitive goods.

SummaryAsset Conclusions - Euribor levels - showing that ECB should be tightening through 2004/05 - represent good value

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