Yesterday, Germany celebrated the anniversary of the fall of the Berlin wall. But also in economic terms, there are several developments to celebrate. I wrote previously about the medium-term trends which seem supportive for the German economy following a decade-long underperformance (see A German history lesson dated Oct 27). Clearly though in a country where "da gibt es nichts zu meckern" (there is nothing to moan about) is the most positive statement you can reasonably expect, providing a non-negative view is not really welcomed.
Nevertheless, I see myself confirmed by the latest data and developments which lend further weight to my view.
Just yesterday the German cabinet backed additional tax cuts which will take effect in 2010 to the tune of EUR 6bn (these cuts still need the approval of the Upper House). The cuts focus on more supportive child benefits, changes in the inheritance tax as well as on changes to the corporate tax code and come on top of a previously agreed income tax cut worth approx. EUR 10bn amid an improved deductibility of health and insurance payments. In combination, these measures therefore provide an additional fiscal stimulus to the magnitute of a bit less than 1% of GDP. Clearly this is not huge but a) they come on top of the significant stimulus measures which started to take effect earlier this year and b) they come against the announced fiscal tightening in a host of other Eurozone countries and c) highlight that there still remains fiscal flexibility in Germany. Moreover, they take place in an environment where the economy has outperformed expectations over the past months and moved back into positive growth territory in Q2 this year. Remember that Q2 growth came in at 0.3% qoq not annualised vs. expectations for -0.2%. Eurozone GDP, however, continued to fall with a qoq rate of -0.1%. Data for German Q3 growth will be released this Friday and expectations are for a rise of 0.8%, i.e. above 3% annualised! Furthermore, given the stronger-than-expected growth in German exports in September as released yesterday, Bloomberg reported that Germany's export-driven recovery would be undermining ECB president Trichet's efforts to slow the currency's record rise (and the calls by Spain, France and Portugal to weaken the euro). Germany's exporters - while being more competitive - are competing relatively more via quality than via price and should therefore be less sensitive to changes in the exchange rate than their co-Euro counterparts. In turn, the rise in the trade-weighted euro of 3% over the past 3 months (doesn't seem that large to me) does not constitue a significant headwind for the German economy.
Additionally, with respect to the monetary environment, besides facing the lowest nominal yields of any Eurozone member states, the disapperance in the inflation gap (i.e. German inflation is not below Eurozone inflation anymore) means that real yields in Germany have come down more than elsewhere.
Overall, it slowly emerges that Germany faces a much more accommodative environment than other Eurozone members. This is just the opposite of what happened at the start of this decade and highlights the improved structural position of the German economy. In this environment, I reiterate that I see a more favorable risk-reward for German corporate bonds than for peripheral government bonds.