The German economy is heading for stagnation in the second half of 2008. The economic engine had already stalled in the second quarter. In the fall the sentiment indicators clouded over further mainly due to the financial market crisis, and the “hard data“ also provide little cause for optimism. However, assuming that the financial market crisis gradually loses its sting in the early months of 2009, we see good prospects for a pickup in the economy next year.

In 2007 earnings of the 30 DAX-listed companies rose sharply. Will this positive trend continue this year? In our Working Paper “No grounds for earnings pessimism” we come to the conclusion that, after four years of brisk increases, the trend in 2008 is likely to be more moderate. But it is encouraging that, even in such a tempestuous year as 2008, the upward trend in earnings will probably not be interrupted.

Following what was probably a fairly buoyant first quarter the German economy is likely to lose momentum in the coming months. Fundamentally, however, it will remain on an expansion path. Given healthy labor market figures and rising wages, private consumption is set to provide a substantial boost in 2008 having languished for years.

Strengthening the innovative strength of Germany and Europe has enormous significance for the preservation of the prosperity level that has been achieved. However, the desired goal of boosting productivity and economic growth will not be achieved by merely upgrading spending on research and development (R&D) – the state must also create conditions conducive to innovation.

The fallout on German economic activity from the correction on the US housing market and the liquidity crisis that erupted in its wake will be very limited. The analysts expect the German economy to continue expanding moderately in the second half of 2007 amid a slight overall deterioration in the overall backdrop and then to grow by 2.3 % in 2008. Investment will continue to boost growth in 2008, and private consumer spending, which has fallen well short of its potential in 2007, will also make a key contribution.

Germany has improved as a business location in recent years and has long been better than its reputation. The macroeconomic facts show that Germany is not doing as badly as its longstanding image would suggest. Germany ranks eighth internationally. According to the study, the best business locations are Sweden, followed by the Netherlands and the UK.

Personal wealth in Germany rose further in 2006. Nonetheless, assets per head of population still lag behind the US, the EU15 or even Japan. Compared with the USA, the annual real return on German financial assets over the past 15 years has been around 1.3 percentage points lower. This is largely attributable to the higher proportion of equities in the wealth structure stateside.

The VAT hike in Germany resulted in only a temporary slowdown in growth. The economy will regain momentum in the second half of the year. The upswing on the labor market will help to stabilize growth. In addition, the encouraging investment backdrop and the rosier outlook for private consumption will also have a positive effect. As a result we have revised our forecast up slightly. For 2007 we now expect to see GDP growth of 2.0 % (previously 1.8 %). In 2008 growth looks set to come in at 2.5 % (previously 2.3 %).

2006 was a good year for German companies. Not only did the number of corporate insolvencies fall sharply for the first time in ages (-17 %), earnings also continued to rise. Earnings at non-financial corporations (according to the national accounts definition) rose by more than 8 % in 2006. This was the third year in a row with a strong increase (2004: + 15.6 %, 2005: + 12.5 %). The extent to which the earnings momentum of recent years will continue, hinges ultimately on future economic developments. Our national-accounts based analysis gives no indication of an imminent reversal in earnings. They remain on a clear upward trend.

Most economists currently put growth in German production potential at 1 to 1.5 %. This is consistent with its average economic growth of 1.3 % in the period 1995 to 2005. Is there a chance of quickly reverting to a permanently higher growth path? We believe so.

In 2007 the upswing will be dealt a temporary blow by the VAT hike. But as the year progresses the economy will gradually stabilize again. We expect GDP growth of 2.4 percent in 2006 and 1.2 percent in 2007. Should the downward trend in oil prices continue, there is still upside potential for growth in 2007.

Born of necessity – no party having secured a clear majority after the September 22, 2005 elections to the Bundestag – the Grand Coalition has now been in office for a good eight months. With the mainstream parties in Germany already comprising such myriad schools of thought in themselves as to make compromise difficult, big parties in coalition fear a serious loss of profile. And they are probably not entirely wrong. Nonetheless, it is widely hoped that a grand coalition will push through decisions pointing the way for the future. Unlike the previous administration, there are now clear majorities in both houses of parliament, Bundestag and Bundesrat. After only eight months it is too early to pass definitive judgment on the Coalition’s work as a whole, but sufficient time has certainly elapsed to issue a first-semester report card.

The evaluation of earnings is one of the most controversial economic variables. With earnings now on the rise again in Germany, but still no improvement on the labor market, this is fueling intense debate.

The German economy is set to regain momentum next year. We expect to see growth of 1.7 % in 2006 after 1 % this year. Euro area GDP growth will also pick up to 1.9 % from 1.3 % in 2005. Growth in the world economy will also remain robust, reaching 3.1 % next year after 3.0 % in 2005. The forecast is based on an average oil price of USD 52 a barrel in 2006 and USD 55 this year.

Although the extremely health momentum seen in 2004 is not likely to be matched, we still expect growth in the world economy of 3.0 % this year and 3.2 % next. In the euro area we expect GDP to increase by 1.5 % this year and 2.1% next year. For Germany we have penciled in 0.8 % in 2005 and 1.8 % in 2006.

The leap in earnings at many German companies is a source of amazement given the desolate employment situation and domestic economic lull. Analysts estimate that annual profits at the 30 companies making up Germany’s DAX stock market index rose by 72 % in 2004. The actual driver of the higher profit level is the improvement in operating results. How can this earnings paradox be explained?

The optimists had their finest hour in the late 1990s. Euphoria ruled on Finanzplatz Deutschland. The stock market boom, the ascendancy of the “Neuer Markt“, the placement of the “people’s share“ Telekom, introduction of the electronic trading platform Xetra and, last but not least, the arrival of the European Central Bank in Frankfurt fueled the most fabulous dreams of Frankfurt’s role in a uniting Europe.

With real growth of around 4 % in 2004, the global economy looks set to notch up its strongest expansion since 2000. Next year, too, we expect to see continued buoyant growth of 3 %. For the euro area we are forecasting an increase in GDP of 2 % both this year and next. For Germany we have penciled in growth of 2 % in 2004 and 1.5 % in 2005.

In recent years the German banking system has shown itself to be stable even under heavy pressure, but its profitability was very poor. The corner has now been turned, above all on the costs side. As the economic backdrop improves, this trend is likely to lead to a sustained catch-up process.

The world economy is currently caught between favorable fundamentals on the one side and the ongoing uncertainty from the threat of terror, regional conflicts and the high oil price on the other. In their latest economic forecast presented in Frankfurt, the economists of Allianz Group and Dresdner Bank expect to see growth in the world economy of 3.3 % in 2004 (2005: 3.1 %). For the euro area they are forecasting an increase in GDP of 1.5 % this year and 2.1 % in 2005, for Germany 1.4 % and 1.6 %.