Eurozone

Ernst & Young Eurozone Forecast

Spring edition March 2013

Austria Belgium Cyprus Estonia Finland France Germany Greece Ireland Italy Luxembourg Malta Netherlands Portugal Slovakia Slovenia Spain

Ernst & Young Eurozone Forecast Spring edition March 2013

Outlook for Germany

17 Eurozone countries

Finland

Estonia

Ireland

Netherlands Belgium Germany Luxembourg Slovakia Austria France Italy Slovenia

Spain Portugal Greece

Malta Cyprus

Published in collaboration with

Highlights
Business investment and exports to drive a return to growth in the first half of 2013

The combination of sound domestic fundamentals, a normalizing risk environment and an improving global growth backdrop means that we expect the German economy to return to growth in the first half of 2013. Despite this, we forecast growth of 0.7% in 2013, a little slower than in 2012, but then the pace is expected to accelerate to 1.9% in 2014. The economy slowed sharply over the past year and ended 2012 with a contraction of 0.6% in Q4. The slowdown was focused on business investment and, to a lesser extent, exports and consumer spending. Despite slowing, Germany still outperformed the rest of the Eurozone in 2012 with growth of 0.9%. Fear of a further sharp deterioration in the economic outlook or another credit crunch caused businesses to curtail investment in plant and machinery in 2012. Despite its recent weakness, the economy remains fundamentally sound. Neither businesses nor households are particularly highly leveraged, and corporate profits have reversed around 95% of the fall seen during the 200809 global financial crisis. Corporate borrowing rates and survey measures of credit constraints are close to historic lows, and the banking sector has made good progress in deleveraging. The German Government is estimated to have balanced its budget in 2012, four years ahead of schedule.

These strong fundamentals provide the foundation for accelerating growth over the next couple of years, led by a pickup in business investment. This prospect is illustrated by the Institute for Economic Research (Ifo) index, which, after falling fairly consistently since March 2011, has risen in each of the last four months, suggesting that the economy has passed its low point. We believe that the risk environment is normalizing again after a period in which it was difficult for companies to have high confidence in the economic outlook and risks were skewed to the downside. This will give companies the confidence needed to start investing again. The fall in peripheral bond spreads and the rise in equity prices and the euro over the last six months suggest that investors also believe the balance of risks has shifted. Weakness in exports also contributed to economic contraction at the end of 2012. Although export order books have only picked up a little so far, we expect the export situation to improve during the course of 2013 as world trade growth accelerates. The rise in world trade will reflect an anticipated pickup in the US economy and a reacceleration of emerging market growth, driven by Asia and Latin America.

Last year saw a sharp rise in concern about unemployment among consumers. But given our forecast that the contraction in output will be short lived, we expect unemployment on the International Labour Organization (ILO) measure to decline to 5.4% in 2013 overall. Consequently, as it becomes clear to consumers that the risk environment is normalizing, we expect fear of unemployment to fall and consumer spending to increase. As a result, we forecast consumer spending growth will accelerate from 0.6% in 2012 to 0.8% in 2013 and then 1.2% in 2014.

Ernst & Young Eurozone Forecast Spring edition March 2013 | Germany

Business investment and exports to drive a return to growth in the first half of 2013
The combination of solid domestic demand, a normalizing risk environment and an improving global growth backdrop means that we expect the German economy to return to growth in the first half of 2013, with GDP seen rising 0.3% in both Q1 and Q2. The economy ended 2012 on a weak note with a contraction of 0.6%. As a result, we expect growth in 2013 to be just 0.7%, before accelerating to 1.9% in 2014.

the economy remains fundamentally sound

Moreover, the German economy remains in good shape. Consequently, we expect growth to average 1.6% a year in 201417, only a little below the pace of the five years prior to the financial crisis. By contrast, we expect the pace of Eurozone growth to be less than two-thirds of its pre-crisis average. The economy is also in pretty robust financial health, which provides the foundations for medium-term growth. Neither businesses nor households are particularly highly leveraged. Non-financial companies have liabilities equal to 95% of GDP, well below the Eurozone average of 138%. Households have been deleveraging since the early 2000s, with the ratio of household debt to income falling from 115% to 92% at the end of 2012. Consequently, both companies and households have the scope to borrow more to fund additional

investment and spending. Surveys show that, unlike their counterparts in the peripheral Eurozone economies, German companies that do not have the internal funds necessary to fund investment have good access to credit. As well as corporate balance sheets being sound, profits have reversed around 95% of the fall they experienced during the 200809 global financial crisis. Relatively low debt levels combined with historically low borrowing rates, at 3.4% for corporates and 7.8% for households, mean that the debt-service burden is low. In addition, the low amount of leverage means that households and companies do not look particularly vulnerable to a rise in interest rates. The banking sector has also made good progress in deleveraging and the Government is estimated to have balanced its budget in 2012, four years ahead of schedule.

Although growth slowed sharply during 2012

The economy slowed sharply over the past year, with growth down from 3.1% in 2011 to 0.9% in 2012, as the Eurozone crisis took its toll. The pace slowed progressively during 2012, with weakness focused on business investment and, to a lesser extent, exports and consumer spending. Despite slowing, Germany outperformed the rest of the Eurozone, which contracted by 0.5% in 2012.

Table 1

Germany (annual percentage changes unless specified)

2012 GDP Private consumption Fixed investment Stockbuilding (% of GDP) Government consumption Exports of goods and services Imports of goods and services Consumer prices Unemployment rate (level) Current account balance (% of GDP) Government budget (% of GDP) Government debt (% of GDP) ECB main refinancing rate (%) Euro effective exchange rate (1995 = 100) Exchange rate ($ per ) 0.9 0.6 -1.9 0.2 1.4 4.3 2.2 2.1 5.5 6.4 -0.1 79.1 0.9 115.5 1.28 2013 0.7 0.8 0.3 0.4 0.9 2.0 2.8 1.6 5.4 6.3 0.0 78.6 0.8 118.7 1.27 2014 1.9 1.2 4.0 0.6 0.7 4.7 5.1 1.7 5.3 5.7 0.0 78.1 0.8 114.3 1.21 2015 1.7 1.2 3.9 0.5 0.7 5.0 5.3 1.8 5.0 5.2 0.0 78.3 0.8 110.7 1.17

Source: Oxford Economics 2016 1.6 1.2 3.2 0.4 0.7 4.9 5.1 1.7 4.7 5.0 0.0 78.4 0.8 110.3 1.17 2017 1.4 1.2 2.8 0.1 0.8 4.6 4.5 1.7 4.4 5.0 0.0 78.6 0.9 110.1 1.17

Ernst & Young Eurozone Forecast Spring edition March 2013 | Germany

Business investment is expected to be a key driver of the return to growth

In addition, a more predictable environment for business planning, increased confidence about the future and a more positive view of the likely return on any new investments will support firms increasing capacity. The Ifo Business Climate Survey illustrates German businesses increased optimism: after falling pretty consistently since March 2011, the index has risen in each of the last four months, driven by a sharp improvement in expectations about the outlook for the next six months. Combining this with healthy corporate finances means that we are upbeat about business investment and expect it to swing from a decline of 2.7% in 2012, and close to zero in 2013, to growth of 5.9% in 2014. Having contracted in each quarter in 2012, we expect business investment to grow by 0.6% in Q1 before expanding steadily as the year progresses and business confidence builds.

The threat of an imminent Eurozone breakup has been averted and the risks from the external environment have also decreased. A compromise deal to tackle the fiscal cliff has reduced downside risks to the US economy, which is expected to strengthen through the year. Also during 2012, there was widespread concern that the Chinese economy would undergo something worse than the soft landing that we were forecasting. However, data released over the last couple of months suggests that after a two-year slowdown the Chinese economy is accelerating again.

reflected in a fall in financial market risk premia

The risk environment is normalizing

It is arguable that fear was a key factor behind the sharp slowdown in growth. We believe that the risk environment is normalizing again after a period in which it was difficult for companies to have high conviction about the outlook for the economy and risks were skewed to the downside.

Since last summer, the reduction in downside risk, particularly the danger of a Eurozone breakup, has been reflected in a near 30% rise in the German equity market, a 12% appreciation of the euro, and a rise in 10-year government bond yields from 1.3% to 1.6%. Bunds were seen as a safe haven by investors fearful of holding the debt of the peripheral Eurozone economies. The rise in the yield on bunds suggests that investors are more confident about the Eurozones survival. If this increased confidence unlocks consumer and business spending, then there is a significant upside risk to our forecast.

Figure 1
Germany: GDP % year 6 4 2 0 -2 -4 -6 -8 -10 2000 2002 2004 2006 2008 2010 2012 2014 2016 GDP % quarter (right-hand side) GDP % year (left-hand side) Forecast % quarter 3 2 1 0

Figure 2
Germany: Non-nancial corporate debt % GDP 106 Forecast

GDP

Non-financial corporate debt

102

98

94

-1
90

-2 -3 -4 -5
86

82

78 1990 1994 1998 2002 2006 2010 2014

Source: Oxford Economics

Source: Oxford Economics

Source: Oxford Economics

Source: Oxford Economics Ernst & Young Eurozone Forecast Spring edition March 2013 | Germany 3

Business investment and exports to drive a return to growth in the first half of 2013
Resilient labor market underpins consumer spending Exports should also recover

However, our forecast assumes a modest pickup in consumer spending, as households have typically shown themselves to be cautious. Although investor sentiment and business confidence have both improved, the best that can be said about consumer confidence is that it may have stopped falling. Given that we do not expect the economy to slide into recession, we expect unemployment to stabilize near current levels, averaging 5.4% on the ILO measure in 2013, down a little from 2012. A diminished fear of unemployment, combined with high employment, strong household balance sheets and above-inflation wage growth, means that we expect consumer spending growth to accelerate from 0.6% in 2012 to 0.8% in 2013 and then 1.2% in 2014. And as it becomes clear to consumers that the Eurozone is no longer in imminent danger of breakup and that the risk environment is normalizing, it is possible that the acceleration in consumer spending growth could be faster than we are forecasting.

Weakness in exports contributed to the contraction in the German economy at the end of last year. Although export order books have only picked up a little so far, we expect the situation to improve during the course of 2013 as world trade growth accelerates on the back of an anticipated sharp pickup in the US economy and a reacceleration of emerging market growth. As a result, we expect exports to swing from contracting by 2% in Q4 2012 to growth of 0.7% in Q1 this year. Export growth is forecast at 2% in 2013 and then 4.7% in 2014.

Euro appreciation may pose a new risk to the economic outlook

Given the high proportion of German GDP accounted for by exports, a further marked appreciation of the euro would pose a new risk to the economy. However, it is a risk that is much less toxic than fears of a Eurozone breakup. Businesses are used to dealing with currency fluctuations, having experienced such bouts of appreciation before.

Figure 3
Germany: Condence 2005 = 100 114 110 106 102 98 94 90 86 82 78 74 2000 2002 2004 2006 2008 2010 2012 Consumer condence (right-hand side) Ifo expectations (left-hand side) % Balance 15 10 5

Figure 4
Germany: Unemployment % 12 11 10 0 -5 -10 -15 -20 6 -25 -30 -35 5 4 1992 1995 1998 2001 2004 2007 2010 2013 2016 9 8 7 Forecast

Confidence

Unemployment

Source: Haver Analytics

Source: Haver Analytics 4 Ernst & Young Eurozone Forecast Spring edition March 2013 | Germany

Source: Oxford Economics

Source: Oxford Economics

Follow the Eurozones progress online

Please visit www.ey.com/eurozone to:
View video footage of macroeconomists and Ernst & Young professionals discussing the future of the Eurozone and its impact on businesses Use our dynamic Eurochart to compare country data over a five-year period Download and print the Ernst & Young Eurozone Forecast and forecasts for the 17 member states

Or follow our ongoing commentary on Twitter at http://twitter.com/EY_Eurozone

Ernst & Young Assurance | Tax | Transactions | Advisory

About Ernst & Young Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 167,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential. Ernst & Young refers to the global organization of member firms of Ernst&Young Global Limited, each of which is a separate legal entity. Ernst&Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit www.ey.com. About Oxford Economics Oxford Economics was founded in 1981 to provide independent forecasting and analysis tailored to the needs of economists and planners in government and business. It is now one of the worlds leading providers of economic analysis, advice and models, with over 300 clients including international organizations, government departments and central banks around the world, and a large number of multinational blue-chip companies across the whole industrial spectrum. Oxford Economics commands a high degree of professional and technical expertise, both in its own staff of over 70 professionals based in Oxford, London, Belfast, Paris, the UAE, Singapore, New York and Philadelphia, and through its close links with Oxford University and a range of partner institutions in Europe and the US. Oxford Economics services include forecasting for 190 countries, 85 sectors and over 2,500 cities and sub-regions in Europe and Asia; economic impact assessments; policy analysis; and work on the economics of energy and sustainability.
The forecasts presented in this report are based on information obtained from public sources that we consider to be reliable but we assume no liability for their completeness or accuracy. The analysis presented in this report is for information purposes only and Oxford Economics does not warrant that its forecasts, projections, advice and/or recommendations will be accurate or achievable. Oxford Economics will not be liable for the contents of any of the foregoing or for the reliance by readers on any of the foregoing.

2013 EYGM Limited. All Rights Reserved. EYG no. AU1474 In line with Ernst & Youngs commitment to minimize its impact on the environment, this document has been printed on paper with a high recycled content.
This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither EYGM Limited nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor. ED None EMEIA MAS 1354.0313