In-between the lines

Frankfurt am Main, (PresseBox) - .
- Official and market forecasts for German growth are rising again
- Domestic demand, especially housing construction, seen as growth engine
- Upward revisions will support positive market momentum

In the second half of last year, we argued strongly against the widespread pessimism in financial markets. In particular, we did not believe in a double-dip recession in the US and a Chinese hard landing. Against this background, we also saw little risk that Germany could get pulled into a recession despite the drag from the Euro debt crisis. By and large our view has prevailed. Nevertheless, our 1.5% growth estimate for Germany in 2012 seemed overly optimistic compared to official and market forecasts. This is starting to change.

Over the last 10 days, three of the five leading German economic research institutes (IfW, IWH and RWI) raised their growth forecasts for this year as well as 2013. Market consensus forecasts have moved higher as well. More revisions from other official and market sources are likely to follow and will probably point in a similar direction. The only exception so far is the forecast of the government's expert advisory board (the so-called 5 "Wiseman"). This, however, was not a full-scale review, but a tiny interim adjustment, which incorporated the weaker data around the turn of the year.

To be sure, our growth outlook is still on the high side. For 2012, the gap is between 0.2 and 0.9 of a percent. For 2013, however, most new estimates are approaching our 2+% growth forecast. In terms of the quarterly profile, this implies that most forecasters still expect some weakness in the first half of this year. In contrast, we expect growth already to resume in the first quarter. Our positive estimate for the first quarter is mostly based on the rise in business confidence indicators, which imply a return to trend growth. The risk to our view is that the pick-up will start later than the indicators imply. Industrial production rose in January, but was still below the fourthquarter average. Thus, industrial production will have to rise further in February and March to validate our view.

Cyclical and monetary shifts

The positive change in German growth forecasts reflects two key developments:

- First, signs that the global business cycle is regaining momentum. In the US, the proof is already in the numbers. In most other economies, rising leading indicators point to a turnaround.

- Second, massive monetary policy support. Most instrumental is the liquidity support from the ECB, which has prevented a financial meltdown in Europe and elsewhere. Furthermore, the policy shift in Emerging Markets, notably China, from tightening to easing provides real stimulus.

German housing recovery becomes reality

In the case of Germany, the improved cyclical and monetary conditions are complemented by positive domestic demand fundamentals. This is nothing new and actual figures have so far disappointed expectations, especially consumer spending. Still, there is reason for optimism. One area where positive fundamentals are starting to materialize is construction, especially for housing. The German housing sector is highly fragmented (by location, demographics and regulation), yet several developments stand out:

- While population growth has stagnated over the last ten years, the number of households has increased by nearly 7%.

- Labor market and income dynamics have improved markedly.

- Mortgage rates are at historical lows, both in nominal and real terms, and banks are happy to lend.

- Discouraged by the financial and Euro debt crisis and worried about inflation, Germans are looking for "real" investment opportunities at home.

- Supply has not kept up with demand. The average housing completion rate over the last ten years was less than 3 units per 1000 residents. For the last five years it was barely two, while 3-to-4 units are needed over time to maintain housing stocks and standards.

- The demand-supply imbalance is likely to increase if better economic performance in Germany leads to more migration from the Euro-area periphery.

To be sure, Germany is unlikely to experience a USstyle housing boom, but recovery is no longer a forecast. The Bundesbank reported in its February monthly bulletin that housing prices rose 5.5% in 2011, after 2.5% in 2010, which is a notable pick-up from the near stagnation in previous years. According to the federal statistics office, housing construction permits rose 22% in 2011. The Ifo institute expects that housing permits will rise 11% in 2012 and another 8% in 2013.

A supplementary development for the construction sector is the fallout from Germany's new energy strategy. First, new energy efficiency rules for housing and tax incentives are leading to investments in insulation and better heating systems. Second, the replacement of nuclear power through renewable energy requires massive investments in the energy infrastructure, which has a large construction component. Against this positive demand backdrop, Germany's construction sector has some catch-up to do. Since the mid 1990s, the number of construction companies fell by 45% and the number of construction workers dropped by 53%. Not surprisingly, the February Ifo survey reported the first positive balance of responses from construction firms in over ten years.

Forecast changes to support market momentum

The change in official and consensus forecasts is important for markets, especially equities. So far, the rally has been driven by better economic news versus low expectations. The result has been short covering. Actual trading volumes have been relatively low. Markets have also been torn between stronger forward looking indicators (e.g. surveys) and softer backward data (e.g. production figures). The positive forecast revisions mean that not just the absence of bad news but genuine optimism will push market sentiment higher.

This development is not only happening at the macro level but at stock levels as well. This is probably not the start of a lasting bull market, given the broader deleveraging environment, but the positive forecast revisions imply that the rally has some momentum left.

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