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German Economy Contracts as Trade Woes Bite -- 2nd Update

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08/14/2019 | 06:05am EDT

By Bojan Pancevski in Berlin and Tom Fairless in Frankfurt

Germany's economy shrank slightly in the second quarter, rekindling fears of a recession and underscoring how Europe's industrial core is suffering from the uncertainty caused by the U.S.-China trade dispute.

Economists and the government have cited the tensions between Beijing and Washington and the possibility of Britain leaving the European Union without a negotiated settlement as the main reasons for the cooling of Germany's export-driven economy.

Analysts said the downturn should be a wake-up call for European policy makers to consider measures to stimulate activity in the region. Berlin, which has generated a budget surplus for the past five years, has been under pressure for months to loosen its strict fiscal policy to energize demand at home and in neighboring countries. The government has resisted any bold move so far, though is planning modest tax cuts and is working on its version of the Green New Deal, to be unveiled this fall.

Germany's gross domestic product shrank 0.1% in the three months to June as a negative hit from foreign trade outweighed solid domestic consumption, according to Germany's statistics agency. While small, the drop is sharply below the 0.4% expansion of the first quarter and considerably below second-quarter eurozone growth of 0.2%. Europe's largest economy -- and long once of the most dynamic -- has now become a drag on the eurozone.

Seasonally adjusted GDP rose 0.2% in both the eurozone and the wider EU compared with the previous quarter, according to the bloc's statistics office. Germany was the only eurozone country whose economy shrank. Outside the currency area, Britain and Sweden also contracted.

"Trade conflicts, global uncertainty and the struggling automotive sector have finally brought the German economy down on its knee. In particular, increased uncertainty, rather than direct effects from the trade conflicts, have dented sentiment and hence economic activity," said ING's chief economist for Germany, Carsten Brzeski.

Early indicators and sentiment surveys point to another weak performance in the third quarter. Economists define a recession as two consecutive quarters of shrinking output.

In the first quarter, Germany's economy grew slightly, narrowly avoiding a recession after a weak end of the year but manufacturing output has been shrinking this year. Difficulties have been particularly pronounced in the country's flagship automotive industry, with manufacturers facing difficulties in implementing new emissions standards, slowing global demand for cars, and a rise in costs as they develop new electric vehicles.

Several large German companies have blamed U.S.-China trade tensions for disappointing results, including software maker SAP SE, chemicals company BASF SE and engineering group Siemens AG.

While research by the Ifo institute, an independent economic think tank, showed that an escalation of the trade war between Beijing and Washington could help EU exports if China's importers substitute some U.S. products for European goods, the uncertainty surrounding the conflict has so far been damaging to demand and investment world-wide.

"Disruption of international trade and the resulting insecurity make it difficult for companies to plan and invest," Ifo President Clemens Fuest said. "This is especially difficult in an export-oriented economy like Germany's."

A raft of disappointing economic data from China on Wednesday, including higher urban unemployment and weak factory production, consumption and property investment data, dispelled hopes of a rebound in one of Europe's largest export markets.

The German data will heap further pressure on the European Central Bank to roll out a large new stimulus package at its next policy meeting on Sept. 12. ECB President Mario Draghi has promised fresh stimulus, which could include interest-rate cuts and hundreds of billions of euros in bond purchases, unless the economy improves.

But after years of aggressive monetary stimulus, Mr. Draghi has warned that the next bout may be less effective. That is especially true in Germany, where borrowing costs are already extremely low.

The eurozone is particularly exposed to international tensions because of its reliance on exports of goods and services, which account for around 28% of eurozone economic output, compared with 12% for the U.S.

At the same time, the 30-year German government bond yield turned negative for the first time earlier this month, as global tensions pushed investors to seek refuge in safe assets, meaning that Berlin can now borrow at unprecedentedly favorable conditions.

The development is prompting a rethinking in Berlin of the decades-old political consensus against any forms of debt-financed stimulus, which is enshrined in the constitution.

Chancellor Angela Merkel has come under pressure from senior members of her coalition partner and from some opposition parties to abandon the iron commitment to budget surpluses and use cheap debt for much-needed investment in infrastructure and green policies.

The opposition Greens, which are alternating between first and second place in opinion polls and look likely to enter a new ruling coalition after the next election, have also called for an end to fiscal orthodoxy. A rare consensus has also emerged among left-leaning and conservative economists that Berlin should invest to help counter the downward cycle.

The government's commitment to surpluses was "a political pledge in a time of high growth, in order to prevent pro-cyclical spending," Mr. Fuest said. "But of course if we enter a recession it is no longer sensible."

Official data released Wednesday also showed that seasonally adjusted industrial production in June fell 1.6% in the eurozone during the second quarter and 1.5% in the EU compared with May.

--Max Bernhard contributed to this article.

Write to Bojan Pancevski at bojan.pancevski@wsj.com and Tom Fairless at tom.fairless@wsj.com

Stocks mentioned in the article
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BASF SE -0.05% 63.89 Delayed Quote.5.78%
E.ON SE -0.63% 9.018 Delayed Quote.4.53%
SAP AG 0.70% 109.86 Delayed Quote.26.38%
SIEMENS AG 0.55% 98.01 Delayed Quote.0.65%
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