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BIG CHANGES AHEAD

The German economy has been hit by the war in Ukraine and the need to increase the speed of the country’s energy independence, writes Scott Hazelton from IHS Markit

The previously expected economic recovery due to largely abolished pandemic-related restrictions in Germany will be delayed given Russia’s invasion of Ukraine. Leading indicators like the Purchasing Managers’ Index (PMI) and the ifo Business Climate Index rebounded in January-February but experienced a setback in March in reaction to the geopolitical shock of the war, the resultant fresh supply chain disruptions and inflation spike, and the Western sanctions imposed on Russia.

This is hurting mostly the industrial sector, whereas service-sector activity is benefiting from consumers being able to satisfy pent-up demand as authorities lifted most restrictions linked to the pandemic.

The key uncertainty lies with the duration of the war, as supply chain disruptions will become worse in the near term despite strong efforts to find alternative sources for various commodities.

Fixed investment will suffer from the sharp rise in uncertainty associated with efforts to reduce the dependency on Russian commodity exports by altering supply chains. Demand for construction will remain supported by structural factors such as pent-up housing demand, migrant needs, historically low interest rates, and additional public spending on transport, energy, IT infrastructure, and the military.

Lost momentum for industry

The German construction sector lost momentum at the end of the first quarter, registering a sharp slowdown in activity growth and a decline in new orders amid elevated levels of uncertainty, fresh supply disruption and heightened inflationary pressures. Building companies faced the steepest rise in input costs for seven months, alongside a record increase in subcontractor rate.

The outlook darkened as a result, with constructors recording a notable deterioration in their expectations for activity in the year ahead to the lowest since May 2020. The headline S&P Global Germany Construction PMI – which measures month-on-month changes in total industry activity – registered 50.9 in March. While this was above the 50.0 threshold that separates expansion from contraction, it is a notable easing of growth.

The slowdown was led by the residential sector, which registered a renewed contraction. Work on commercial building projects continued to increase, though the pace of expansion eased.

Of the three broad construction categories monitored by the survey, civil engineering activity maintained the most momentum in March, registering growth only slightly slower than the 55-month high recorded in the previous survey period.

Source: IHS Marklit

Overall inflows of new orders across the German construction sector fell in March, partially reversing the increases that had been seen in the prior two months. Firms blamed a number of factors, including elevated prices, material shortages and hesitancy among clients, all of which had been exacerbated by the war in Ukraine.

German constructors reported an acceleration in rate of input price inflation, taking it closer to the record highs seen in the second half of last year. This was attributed to sharp increases in energy, material and transport prices, with the war in Ukraine and an associated squeeze on supply cited as contributing factors.

The incidence of supplier delays increased sharply to its highest for eight months in March and surveyed businesses often commented on a shortage of steel.

The outlook for German construction has changed from a slow improvement for 2022 to barely registering growth. Total real construction spending was expected to grow 2.4% in 2022, an outlook now reduced to 0.8%. If the myriad issues impacting the industry begin to resolve this year, growth can improve to 3.5% in 2023 and 3.0% in 2024.

Office construction offers little to no improvement as companies assess actual space needs in the wake of the pandemic. The greatest challenge though is to the commercial sector. While the hospitality industry offers potential as it recovers from its deep pandemic slump, the large retail sector will be a hindrance to growth as e-commerce consumes an ever-larger share of spending and conventional store growth falls. While warehousing and logistics will see strong growth, the value of these structures is lower than that of retail.

Established in 1959, IHS is the leading source of information, insight and analytics in critical areas that shape today’s business landscape. Businesses and governments in more than 150 countries around the globe rely on the comprehensive content, expert independent analysis and flexible delivery methods of IHS to make high-impact decisions and develop strategies with speed and confidence. Headquartered in Colorado, US, IHS employs about 8,800 people in 32 countries.

infrastructure investment?

Infrastructure also recovers, as the end of Covid-support spending allows for funds to be re-purposed, particularly into energy and transportation projects. Germany’s new government has made infrastructure a priority, although it remains to be seen whether the need for additional defense spending requires re-assessment.

There is some potential in new manufacturing construction in 2022, although some of that will be recovering ground lost in 2020 and 2021. While some new investment has moved to Eastern European countries, domestic investment remains critical.

Overall, manufacturing will become less important to the construction economy as the rate of growth recedes over the next decade. However, utilities will be a winner as Germany not only works toward a net zero economy itself, but also exports that technology. As energy independence is achieved, refining becomes less important. Some petroleum-based activity will remain to support the chemical industry, which will also see growth.

Transportation equipment investment has a very strong near term, but may tail off as plants complete transition to electric vehicles with fewer parts. Electrical and electronics industries will pick up some of that slack. iC

This article appears in April 2022

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April 2022
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