German Industry Shows Surprising Resilience In June

Despite higher energy prices and the war in the Middle East, German industry continued its modest cyclical rebound, with an improvement in June. However, whether this rebound can really translate into a structural and sustainable recovery remains a different story.

Industrial production continues its cyclical recovery. In June, German industrial production increased by 0.2% month-on-month, from 0.7% MoM in May. On the year, industrial production was slightly down (-0.1%). The June increase was mainly driven by stronger production in the automotive industry. At the same time, exports increased by 0.9% MoM, from 0.9% in May, confirming that net exports were the main drivers of growth in the second quarter.

Despite the war in the Middle East and soaring energy prices, industrial production is proving resilient. Some industries or companies actually seem to have benefited from the war in the Middle East, as Asian competitors were hit harder by the closure of the Strait of Hormuz. However, don't mistake a cyclical rebound for structural improvement. This is still only a cyclical rebound from low levels. The latest Chinese trade data, for example, shows that Germany’s bilateral trade deficit with China grew in July – indicating that any cyclical improvement in industry should not obscure the view of German industry’s structural problems. Also, even with the latest improvements, industrial production remains some 10% below pre-pandemic levels.

Cyclical rebound to continue

Looking ahead, it is obvious that the short-term outlook for the German economy is highly dependent on energy prices, the war in the Middle East and the current heatwave. Even if the German economy has proven more resilient than some had feared, an expansion of the conflict into other trade routes would obviously pose a new risk to the economic rebound. If developments of the last days prevail, bringing a ceasefire and another opening of the Strait, the outlook for German industry would obviously immediately improve. With production expectations at the highest level since February and order books gradually filling, there is indeed reason for optimism. On the other hand, the warm and dry summer weather has brought water levels in main transportation waterways to record low levels, potentially affecting industrial supply chains and activity in the construction sector (we've written in more detail about this here).

Looking beyond the near-term outlook, the German economy will still be driven by fiscal stimulus and investments in defence and infrastructure, as well as the ability to translate recent reform plans into real and tangible action. In this delicate mix of short-term downside risks and longer-term optimism, let’s not forget that to fundamentally bring the German economy back on a sustainable growth path, the economy still needs more reforms that improve international competitiveness, a clear plan for affordable energy and more direct incentives, e.g. tax cuts, to boost domestic demand, and both corporate investments and private consumption. Elements that are currently still missing in the recently announced reform package. Not only will the government have to add more structural reforms, given weak domestic demand, the good old Keynesian toolkit might also have to be dusted off.

In this regard, a lot will depend on whether the latest political turbulence in Berlin will ease over the summer and also give a political reset. If they don’t, the risk is high that increasing tensions within the government as well as possible wins by the AfD in the upcoming state elections in September will choke off any additional reform efforts.

All in all, German industry has shown surprising resilience. Whether this resilience and the current cyclical rebound can really translate into a structural recovery remains a different story.