Country Report. Germany. Generated on September 27th Economist Intelligence Unit 20 Cabot Square London E14 4QW United Kingdom

Country Report Germany Generated on September 27th 2017 Economist Intelligence Unit 20 Cabot Square London E14 4QW United Kingdom

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Germany 1 Germany Forecast Highlights 2 4 4 5 5 5 6 7 8 8 8 9 9 10 11 12 13 14 15 16 16 18 21 21 27 36 Outlook for 2017-21 Political stability Election watch International relations Policy trends Fiscal policy Monetary policy International assumptions Economic growth Inflation Exchange rates External sector Forecast summary Quarterly forecasts Data and charts Annual data and forecast Quarterly data Monthly data Annual trends charts Quarterly trends charts Monthly trends charts Comparative economic indicators Summary Basic data Political structure Recent analysis Politics Forecast updates Analysis Economy Forecast updates Analysis

Germany 2 Highlights Editor: Emily Mansfield Forecast Closing Date: September 8, 2017 Outlook for 2017-21 Review The Economist Intelligence Unit expects the centre-right Christian Democratic Union (CDU) to win the largest vote share in the election on September 24th, significantly ahead of the centre-left Social Democratic Party (SPD). The CDU will subsequently take the lead in coalition negotiations, resulting in a new government led once again by Angela Merkel, the current chancellor, who will thus remain in office for a fourth consecutive term. We expect a coalition to emerge comprising the CDU and its Bavarian sister party, the Christian Social Union (CSU), with one or two of the smaller parties. Another CDU-SPD grand coalition is an alternative possibility. Germany will continue to play a substantial international role, remaining dominant in both euro zone and EU debates, and in the Brexit negotiations. Shaping the bloc's response to the US, Turkey and Russia will be a priority. Significant macroeconomic policy initiatives, or serious reforms to tackle long-term demographic challenges, are unlikely under the next government. We expect a slight easing of fiscal policy after the election, with a combination of a modest increase in public investment and income tax cuts. Nevertheless, the budget will remain in surplus in the 2017-21 forecast period. We expect the recent domestic demand driven pick-up in growth to be maintained this year and next, with real GDP growth of 2% on average. This will be followed by a moderation to 1.5% growth on average in 2019-21. Germany's large, and often controversial, current-account surpluses will persist, although we expect them to decline gradually over 2017-21, from 8.3% of GDP in 2016 to just below 6% in 2021. The Infratest dimap poll conducted on August 28th-30th gave Ms Merkel a 14 percentage point lead over her SPD challenger, Martin Schulz. Her share of voting intentions, at 37%, has been broadly stable over the summer months. The only televised debate between Ms Merkel and Mr Schulz was a sedate affair with significant agreement between the two candidates. Ms Merkel was judged the most convincing by a majority of viewers. Real GDP expanded by 2.1% year on year in the second quarter, up from 1.9% in the first quarter, according to the seasonally and working-dayadjusted estimate from the Federal Statistical Office (Destatis). Private consumption and gross fixed capital formation saw particularly robust quarterly growth. The flash composite purchasing managers' index strengthened in August. However, the ZEW financial survey eased sharply amid automotive sector concerns about the diesel emissions scandal and alleged cartel behaviour. Outlook for 2017-21 Political stability Germany is currently governed by a grand coalition comprising the centre-right Christian Democratic Union (CDU), its smaller Bavarian sister party, the Christian Social Union (CSU), and the centre-left Social Democratic Party (SPD). The

Germany 3 government is led by Angela Merkel, who is in her third term as chancellor. The Economist Intelligence Unit expects the CDU to win a plurality of votes in the federal election on September 24th, but not a majority of seats: recent polls show that the CDU has about 37% of public support, ahead of the SPD on 23%. As a result, a variety of CDU-led coalitions are possible, with Ms Merkel remaining as chancellor. Over the past decade Ms Merkel has captured most of the middle ground in a country that has enjoyed several years of economic stability and growth. A recent poll showed that 81% of the electorate were happy with their own economic situation an all time high, reflecting the lowest unemployment rate since reunification in 1991. This positive domestic situation is driving support for the status quo, as is a more challenging external environment in the light of the sometimes unpredictable actions of Donald Trump, Vladimir Putin and Recep Tayyip Erdogan, the presidents of the US, Russia and Turkey respectively. Ms Merkel is often criticised for preferring to "manage" than to provide strategic leadership. However, her refusal to take strong positions on hot topics, and her ability to look at long-term shifts in public opinion on any given issue and position herself so she can appeal to both sides, is an effective electoral strategy. Not only does this make her hard to attack, but it also makes her mostly inoffensive to her opponents' supporters, making them harder to mobilise. Ms Merkel's one misstep in this respect was her reaction to the migrant crisis in 2015-16, with her broadly welcoming response to a surge of migrant arrivals proving out of step with majority public opinion. However, a sharp drop in the number of arrivals last year to 280,000, from 900,000 in 2015 combined with a hardening of the government's stance towards migrants, reduced the political salience of the issue and eased the pressure on her. Given the equally pragmatic positions of the CDU and the SPD on this issue, the far-right populist Alternative for Germany (AfD) is the only party addressing voters' concerns about migration and Islam head-on. With around 10% support in the polls, we expect it to enter the Bundestag (the lower house of parliament) for the first time in September, giving it greater influence over the terms of political debate. This will be a significant moment for German politics, marking the first time that a far-right party is represented in the Bundestag in the post-war period. However, support for the AfD has eased back since the height of the migrant crisis, and none of the other parties will countenance going into coalition with it, limiting its political influence. For a short period in early 2017 it looked as if Martin Schulz, the former presi-dent of the European Parliament who replaced Sigmar Gabriel as SPD chairman in January, might be able to shake up the political scene. Support for the SPD shot up by 10 percentage points after his arrival, suggesting a desire among the electorate for new faces and ideas, but then fell back, with the party losing three successive state elections. Mr Schulz's emphasis on social justice calling for a looser fiscal stance, with more tax cuts and investment aimed to tap into voter concerns about slow wage growth and inequality. However, he has struggled to expand the appeal of his ideas beyond core SPD voters, given the strong economic context and the fact that the CDU's programme is very similar. Over the medium term, as the 2021 federal election approaches, questions about who might succeed Ms Merkel as the dominant figure on the centre right will become more pressing. This means that the political scene will be less stable over our forecast period (2017-21) than it has been over the past decade.

Germany 4 Election watch We expect the CDU to win the largest share of the vote in the federal election on September 24th and then to lead the negotiations to form a new coalition. Which party or parties it chooses to govern with will depend on minor differ ences in vote share for the smaller parties. The liberal Free Democratic Party (FDP) would probably be Ms Merkel's preferred coalition partner, should these parties win a majority of seats, but this looks increasingly unlikely according to the latest opinion polls. A coalition with the FDP and The Greens might be another option (the socalled Jamaica coalition). This would probably ensure a majority, but might be difficult to negotiate given deep-seated policy differences between the FDP and The Greens. Should none of these options prove practicable, the CDU could alternatively form another grand coalition with the SPD, although we expect the SPD in particular to be hesitant about this option as it would mean another four years of languishing in Ms Merkel's shadow. Frank-Walter Steinmeier (SPD) began a five-year term in the largely ceremonial post of federal president in March 2017. An early state election will be held in Lower Saxony on October 15th, after the collapse of the SPD-Green coalition. International relations Ms Merkel's desire to remain on the political scene by running for another term as chancellor is undoubtedly driven at least in part by international develop ments. The UK's vote to leave the EU, strains over the migrant relocation agreement, and the challenges to the bloc posed by the governments in Hungary and Poland have strained the European community. Meanwhile, further afield, the actions of Mr Trump, Mr Putin and Mr Erdogan are serving to undermine the global rules-based order that Germany has always held as the gold standard. Germany nonetheless remains hesitant about taking on the mantle of "leader of the free world", proposed in the wake of Mr Trump's election, given the country's role in European history and its already oversized political and economic clout in the EU. The election of Emmanuel Macron as president of France was therefore welcomed in Germany as a way to enable a more balanced Franco-German partnership at the heart of the bloc. The extent to which Germany will support Mr Macron's plans for a more integrated euro zone will partly depend on the coalition that emerges (the FDP in particular is strongly against further risk sharing), and partly on France making progress towards a smaller budget deficit and stronger GDP growth. However, there is an increasing consensus in Germany that euro zone reform, and a multi-speed Europe, is now a necessity. The US is and will remain Germany's most important non-eu partner on the global stage, but the relationship between Mr Trump and Ms Merkel has been rocky so far. Mr Trump is critical of Germany's trade surplus with the US and its bel0w-target spending on defence. We expect tensions to continue in the coming years and Germany to work towards lessening its dependency on the US for defence, with military spending planned to rise from 1.2% of GDP at present to the 2% NATO target by 2024. In the meantime, Ms Merkel will continue to manage the relationship to avoid confrontations with Mr Trump. Following the annexation of Crimea in 2014 Germany took a decisive line against Russia, breaking with decades of relatively good relations and pushing against the reluctance of many south and central European nations to impose far-reaching EU sanctions, a position that it has maintained ever since. We expect these sanctions to remain in place over the medium term, although pragmatic co-operation between Germany and Russia will continue, especially on energy.

Germany 5 Policy trends The presence of the SPD in the current coalition has enabled progress on some typically social democratic policy goals, including the introduction of a lower retirement age for some workers, and a statutory minimum wage. The specific policies of the next government will be determined by the make-up of the eventual coalition, but we expect a slightly looser fiscal stance, involving some tax cuts and a much-needed increase in public investment spending. Germany s economic fundamentals are currently strong, but we expect significant challenges to growth and the public finances to emerge by the 2020s owing to poor demographic trends, with the working-age population expected to start declining from 2017. Nonetheless, short-term political considerations are likely to prevent the kind of structural reforms that Germany needs in order to mitigate the impact of its ageing population on growth. Possible steps to increase labour force participation will start to be debated more seriously as the problem becomes more urgent over the medium term. Fiscal policy Steady consolidation of the public finances has been a key focus of the current government, which in 2016 met its schwarze Null target a balanced federal budget on the national measure for the third consecutive year, at 0.8% of GDP. Public spending will be nudged upwards during the forecast period by increased health and long-term care expenditure. Moreover, most parties agree on the desirability of some slight fiscal loosening, with the main difference in their plans being the balance between additional investment and tax cuts. Nonetheless, with revenue growth remaining solid we expect the public finances to remain comfortably in surplus throughout our forecast period. As a result, the public debt/gdp ratio will continue to fall, from a peak of 81.1% in 2010 to lower than the EU mandated limit of 60% from 2020. Monetary policy The European Central Bank (ECB) is pursuing an exceptionally accommodative monetary policy, with major policy interest rates at or below zero; a series of socalled targeted longer-term refinancing operations (TLTROs) aimed at pushing banks to lend more money; and a 60bn per month quantitative easing (QE) programme, which will run until the end of 2017. However, the economic recovery in the euro zone has maintained momentum supported by an acceleration in credit growth and looks to be more broad based. We expect another healthy expansion of real GDP in the euro zone in 2017, of 2%, after growth of 1.9% on average in 2015-16. Although commentary from the ECB's president, Mario Draghi, was cautious in tone following the policy meeting in July, Mr Draghi revealed that the bank's policysetting governing council would be discussing the future of the QE programme in the autumn of this year. We maintain our view that the bank will begin to wind down gradually, or "taper", the programme in 2018. Nevertheless, underlying price pressure remains relatively subdued, and downside risks to wage growth and the global economy during that year could yet slow the pace at which the ECB will reduce its monthly asset purchases. We forecast that the ECB will not raise policy rates before the end of our forecast period, in 2021.

Germany 6 International assumptions 2016 2017 2018 2019 2020 2021 Economic growth (%) US GDP 1.5 2.1 2.1 2.2 0.8 1.9 OECD GDP 1.7 2.1 1.9 1.9 1.2 1.9 EU28 GDP 1.9 2.1 1.8 1.7 1.6 1.7 World GDP 2.3 2.8 2.6 2.6 2.2 2.7 World trade 2.5 4.0 3.2 3.1 2.4 3.7 Inflation indicators (% unless otherwise indicated) US CPI 1.3 1.9 2.0 2.2 1.3 1.8 OECD CPI 1.0 2.0 1.8 1.9 1.7 1.8 EU28 CPI 0.3 1.7 1.6 1.7 1.7 1.8 Manufactures (measured in US$) -1.8 1.4 2.0 5.9 4.1 4.5 Oil (Brent; US$/b) 44.0 52.1 50.8 53.1 52.9 55.5 Non-oil commodities (measured in US$) -3.0 6.4 0.3 2.1-2.6 2.5 Financial variables US$ 3-month commercial paper rate (av; %) 0.5 1.2 2.0 2.3 1.6 1.2 3 month interbank rate (av; %) -0.3-0.2 0.0 0.1 0.2 0.3 US$: (av) 1.11 1.13 1.16 1.15 1.20 1.20 : (av) 120.35 125.72 126.97 126.89 123.65 119.50

Germany 7 Economic growth Real GDP expanded by 1.9% in 2016, driven mainly by private consumption and strongly supported by migrant-related public spending. Quarterly growth rates picked up in the first half of 2017, to 0.7% in January-March and 0.6% in April-June, and sentiment indicators point to continued strong output growth in the third quarter. We have revised up our full-year growth forecast to 2.1%, from 1.9%, in line with a cyclical upturn currently under way across the euro zone. Private consumption will be the main driver of growth again this year as employment continues to rise and nominal wage growth strengthens, although real disposable incomes will be constrained by an uptick in inflation. Increases in state pensions and low borrowing costs will further support household spending. These factors are contributing to a small housing market boom, with brisk growth in mortgage loans, robust construction activity and decent house price growth. Meanwhile, expansionary conditions in industry and the highest rate of capacity utilisation since 2011 are supporting investment in machinery and equipment. We therefore expect gross fixed capital formation to provide a further spur to growth this year. In 2018 we expect the current upturn to continue, with growth of 1.8%. Domestic conditions will continue to be supportive in the remainder of the forecast period, but we expect growth to slow to around its potential rate in 2019-21, at 1.5% on average. In part, this deceleration reflects our expectation of a sharp policy-led slowdown in China in 2018, to which Germany is particularly exposed because of strong Chinese demand for German manufactured goods. Downside risks to the economic outlook include a more protectionist US trade policy and a disorderly Greek exit from the euro zone, although neither of these forms part of our core scenario. The fact that the country's flagship industry, the automotive sector, risks being disrupted by technological change after a long-term emphasis on diesel technology presents a further challenge. Over the longer term Germany's poor demographic outlook will increasingly constrain potential growth, with the working-age population declining. Economic growth % 2016 a 2017 b 2018 b 2019 b 2020 b 2021 b GDP 1.9 2.1 1.8 1.5 1.4 1.5 Private consumption 1.9 2.1 1.7 1.5 1.3 1.4 Government consumption 3.7 1.6 1.6 1.3 1.4 1.4 Gross fixed investment 2.9 3.0 1.8 1.9 2.1 1.8 Exports of goods & services 2.4 3.9 3.6 3.4 2.9 3.3 Imports of goods & services 3.8 4.4 3.9 3.8 3.3 3.5 Domestic demand 2.4 2.2 1.8 1.6 1.6 1.5 Agriculture -0.6-0.4 0.4 0.6 0.5 0.2 Industry 1.7 1.6 1.1 1.2 0.9 1.0 Services 1.9 2.4 2.1 1.7 1.7 1.8 a Actual. b Economist Intelligence Unit forecasts.

Germany 8 Inflation Headline EU harmonised inflation has been low or negative for the past three years, averaging just 0.4% in 2016. Temporary energy price-related base effects started to push up inflation in late 2016, and in February 2017 price growth reached 2.2% its fastest rate since August 2012. Subsequently, inflation eased as the base level for annual energy price comparisons rose, bringing average inflation in January-August to 1.7%. Underlying inflationary pressures remain fairly weak, but will strengthen gradually as the labour market tightens. As we expect only a modest further recovery in energy prices, we forecast that price growth will remain weaker than the ECB's target of "below, but close to, 2%". Nevertheless, relative economic outperformance will keep it above the euro zone average. We forecast average annual German inflation of 1.6% in 2017 21. Exchange rates The euro has moved in a relatively narrow range around US$1.10: 1 since mid 2015. The annual average exchange rate was US$1.11: 1 in 2016, although a sharp appreciation in the value of the US dollar following the presidential election in the US led to a year end rate of US$1.05: 1. The euro has since rallied as the region's economic recovery has continued, and as political risk has waned in Europe but risen in the US. More recently, a rise in expectations of QE tapering by the ECB has prompted a sharp appreciation in the euro against the dollar. The value of the euro could yet come under pressure from political risk especially in relation to the next general election in Italy, which we expect to take place in early 2018 and monetary tightening in the US. Nevertheless, we expect a gradual appreciation on average, to US$1.20: 1 by 2020, as the euro is supported by an ongoing recovery in the region and receives structural support from a large current-account surplus. A business cycle downturn in the US will weigh on the value of the dollar in 2020. External sector Germany's sizeable current-account surplus declined slightly in 2016, to 8.3% of GDP, from a historical high of 8.5% in 2015. Despite a pick-up in energy prices this year, Germany will continue to post huge trade surpluses, reflecting the competitiveness of its manufacturing sector and comparatively low levels of domestic consumption and investment. This will continue to generate large domestic savings that are mainly invested abroad, leading to a solid primary income surplus. Trade and primary income surpluses will comfortably outweigh small structural deficits on the services and secondary income accounts. We expect the current-account surplus to remain substantial throughout the forecast period, declining only slightly, to just below 6% of GDP by 2021. These large surpluses will con tinue to provoke criticism, within Europe and globally, about Germany s role in prolonging demand shortfalls in much of the rest of the euro zone.

Germany 9 Forecast summary Forecast summary (% unless otherwise indicated) 2016 a 2017 b 2018 b 2019 b 2020 b 2021 b Real GDP growth 1.9 2.1 1.8 1.5 1.4 1.5 Industrial production incl construction (% change) 1.2 2.5 1.6 1.4 1.0 1.2 Unemployment rate (av; national measure) 4.2 4.3 4.2 4.4 4.6 4.8 Unemployment rate (av; EU/OECD standardised measure) 4.2 4.3 4.2 4.4 4.6 4.8 Consumer price inflation (av; national measure) 0.5 1.7 1.6 1.7 1.8 1.9 Consumer price inflation (av; EU harmonised measure) 0.4 1.6 1.5 1.6 1.7 1.8 Short-term interbank rate -0.3-0.2 0.0 0.1 0.2 0.3 Government balance (% of GDP) 0.8 0.7 0.6 0.4 0.4 0.2 Exports of goods fob (US$ bn) 1,322 1,429 1,519 1,608 1,716 1,809 Imports of goods fob (US$ bn) -1,022-1,128-1,210-1,318-1,420-1,538 Current-account balance (US$ bn) 289.0 285.0 284.8 281.2 270.3 250.7 Current-account balance (% of GDP) 8.3 7.8 7.3 7.1 6.4 5.7 Exchange rate US$: (av) 1.11 1.13 1.16 1.15 1.20 1.20 Exchange rate US$: (end period) 1.05 1.18 1.16 1.17 1.20 1.19 Exchange rate 100: (av) 1.20 1.26 1.27 1.27 1.24 1.20 Exchange rate : (av) 1.22 1.13 1.07 1.06 1.04 1.08 a Actual. b Economist Intelligence Unit forecasts. Quarterly forecasts Quarterly forecasts 2016 2017 2018 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr GDP % change, quarter on quarter 0.6 0.5 0.3 0.4 0.7 0.6 0.5 0.4 0.4 0.5 0.5 0.4 % change, year on year 1.8 1.9 1.9 1.9 1.9 2.1 2.2 2.3 1.9 1.8 1.8 1.8 Private consumption % change, quarter on quarter 0.6 0.2 0.4 0.6 0.4 0.8 0.6 0.4 0.3 0.4 0.4 0.4 % change, year on year 2.1 1.9 1.7 1.8 1.6 2.2 2.5 2.2 2.1 1.7 1.5 1.5 Government consumption % change, quarter on quarter 1.5 0.7 0.2 0.5 0.2 0.6 0.5 0.1 0.4 0.5 0.5 0.4 % change, year on year 4.1 4.3 3.4 3.0 1.6 1.5 1.8 1.4 1.6 1.5 1.5 1.8 Gross fixed investment % change, quarter on quarter 1.2-1.2 0.5 0.0 2.7 1.0-1.7 1.8 0.4 0.5 0.5 0.4 % change, year on year 4.7 3.4 3.0 0.5 2.0 4.3 1.9 3.8 1.4 0.9 3.2 1.8 Exports of goods & services % change, quarter on quarter 1.0 1.3-0.2 1.3 1.6 0.7 0.1 1.7 0.7 0.9 0.8 0.8 % change, year on year 2.6 2.2 1.6 3.4 4.1 3.5 3.8 4.2 3.3 3.4 4.2 3.3 Imports of goods & services % change, quarter on quarter 1.7-0.2 0.7 2.5 0.4 1.7-0.2 2.1 0.7 0.8 0.8 0.8 % change, year on year 4.0 3.4 3.0 4.9 3.5 5.4 4.5 4.1 4.4 3.5 4.5 3.1 Domestic demand % change, quarter on quarter 0.9-0.2 0.8 0.8 0.1 1.0 0.2 1.0-0.2 0.6 0.6 0.7 % change, year on year 2.3 2.4 2.5 2.3 1.5 2.8 2.2 2.3 2.0 1.6 2.0 1.7 Consumer prices % change, quarter on quarter -0.4 0.4 0.3 0.7 0.5 0.0 0.3 0.3 0.4 0.5 0.5 0.4 % change, year on year 0.1 0.0 0.4 1.0 1.9 1.6 1.6 1.2 1.1 1.5 1.7 1.8 Producer prices % change, quarter on quarter -1.2 0.1 0.3 0.9 1.4 0.1 0.1-0.1 0.3 0.3 0.4 0.4 % change, year on year -2.7-2.6-1.7 0.2 2.7 2.7 2.5 1.5 0.4 0.6 0.8 1.3 Exchange rate :US$ Average 0.91 0.89 0.90 0.93 0.94 0.91 0.85 0.85 0.85 0.86 0.86 0.86 End-period 0.88 0.90 0.90 0.95 0.94 0.88 0.85 0.85 0.86 0.86 0.86 0.87 Interest rates (%; av) Money market rate -0.2-0.3-0.3-0.3-0.3-0.3-0.1-0.1 0.0 0.0 0.0 0.0 Long-term bond yield 0.3 0.1-0.1 0.1 0.3 0.3 0.5 0.6 0.7 0.7 0.8 0.9

Germany 10 Data and charts Annual data and forecast 2012 a 2013 a 2014 a 2015 a 2016 a 2017 b 2018 b GDP Nominal GDP (US$ bn) 3,548 3,760 3,903 3,374 3,473 3,665 3,895 Nominal GDP ( bn) 2,760 2,831 2,937 3,041 3,139 3,240 3,351 Real GDP growth (%) 0.7 0.6 1.9 1.5 1.9 2.1 1.8 Expenditure on GDP (% real change) Private consumption 1.3 0.8 1.0 1.6 1.9 2.1 1.7 Government consumption 1.1 1.4 1.5 2.9 3.7 1.6 1.6 Gross fixed investment -0.1-1.2 3.7 1.0 2.9 3.0 1.8 Exports of goods & services 3.5 1.9 4.5 4.7 2.4 3.9 3.6 Imports of goods & services 0.4 3.1 3.5 5.2 3.8 4.4 3.9 Origin of GDP (% real change) Agriculture -0.7 5.0-12.0 15.8-0.6-0.4 0.4 Industry 0.1-0.4 5.0 1.3 1.7 1.6 1.1 Services 1.1 1.1 0.7 1.1 1.9 2.4 2.1 Population and income Population (m) 80.5 80.8 81.2 82.2 82.6 82.8 82.8 GDP per head (US$ at PPP) 43,534 45,235 47,141 47,842 48,851 50,684 52,668 Recorded unemployment (av; %) 5.4 5.2 5.0 4.6 4.2 4.3 4.2 Fiscal indicators (% of GDP) General government budget revenue 44.2 44.5 44.5 44.6 45.0 44.9 44.7 General government budget expenditure 44.3 44.6 44.2 43.9 44.2 44.2 44.1 General government budget balance 0.0-0.2 0.3 0.7 0.8 0.7 0.6 Public debt 79.9 77.4 74.6 71.0 68.2 65.4 62.6 Prices and financial indicators Exchange rate US$: (end period) 1.32 1.38 1.21 1.09 1.05 1.18 1.16 Exchange rate : (end period) 114.3 145.2 145.5 130.9 123.1 128.5 126.5 Consumer prices (end-period; %) 2.0 1.4 0.0 0.2 1.7 1.1 1.6 Producer prices (av; %) 1.7 0.0-0.9-1.8-1.7 2.3 0.8 Lending interest rate (av; %) 3.0 2.7 2.5 1.8 1.6 1.8 2.0 Current account (US$ bn) Trade balance 257 282 303 290 301 301 310 Goods: exports fob 1,377 1,435 1,482 1,308 1,322 1,429 1,519 Goods: imports fob -1,120-1,152-1,179-1,018-1,022-1,128-1,210 Services balance -42-55 -34-21 -25-24 -20 Primary income balance 84 83 74 64 57 60 52 Secondary income balance -50-58 -55-45 -44-52 -56 Current-account balance 249 252 288 288 289 285 285 a Actual. b Economist Intelligence Unit forecasts. Sources: IMF, International Financial Statistics; European Central Bank; Federal Statistical Office; UN; Eurostat; OECD.

Germany 11 Quarterly data 2015 2016 2017 3 1 2 4 Qtr 3 Qtr Qtr Qtr Qtr 4 Qtr 1 Qtr 2 Qtr Central government finances ( bn) Revenue 85.9 91.5 81.1 87.5 85.2 90.9 88.2 n/a Expenditure 89.0 83.4 83.6 73.6 88.6 92.5 84.6 n/a Balance -3.1 8.1-2.5 13.9-3.4-1.6 3.6 n/a Output (seasonally adjusted) GDP at chained 2010 prices ( bn) a 700.8 703.8708.2711.5 713.9 716.9 722.0 726.4 GDP at chained 2010 prices (% change, year on year) 1.8 1.3 1.8 1.9 1.9 1.9 1.9 2.1 GDP at chained 2010 prices (% change, quarter on quarter) 0.3 0.4 0.6 0.5 0.3 0.4 0.7 0.6 Manufacturing industry (2010=100) 110.3 110.1111.9111.4 111.5 111.8 113.1 114.6 Intermediate goods 106.0 106.2107.5106.9 107.0 107.7 109.0 110.6 Capital goods industry 118.0 117.7119.9119.1 119.1 119.2 120.8 122.3 Consumer durables 103.0 103.0104.7105.8 106.0 107.2 107.9 112.0 Other consumer goods 102.2 101.0103.0103.1 103.1 102.7 104.2 104.9 Employment, wages and prices Employment (seasonally adjusted; m) 43.1 43.3 43.4 43.6 43.7 43.9 44.1 44.2 EU harmonised unemployment rate (seas adj; % of the labour force) 4.5 4.5 4.3 4.2 4.1 4.0 3.9 3.8 Jobs vacant ('000) 872.91,047.1988.7985.2 923.21,054.91,064.0 n/a Negotiated monthly earnings (2010=100) 112.7 113.1113.7114.5 115.1 115.6 116.5 116.9 EU harmonised consumer prices (2015=100) 100.0 100.2 99.8100.1 100.5 101.2 101.7 101.7 EU harmonised consumer prices (% change, year on year) 0.0 0.2 0.1 0.0 0.4 1.0 1.9 1.6 Producer prices, seas adj, manufacturing (2010=100) 104.0 103.0101.8101.9 102.2 103.1 104.5 104.7 Financial indicators Exchange rate US$: (av) 1.11 1.09 1.10 1.13 1.12 1.08 1.06 1.10 Exchange rate US$: (end period) 1.12 1.09 1.14 1.11 1.12 1.05 1.07 1.14 ECB repo rate (end-period; %) b 0.05 0.05 0.00 0.00 0.00 0.00 0.00 0.00 3-month Euribor rate (av; %) 0.0-0.1-0.2-0.3-0.3-0.3-0.3-0.3 DAX share price index (end-period; Dec 30th 1987=1,000) 9,660 10,7439,9669,68010,511 11,481 12,31312,325 Sectoral trends (seasonally adjusted) New orders, volume (2010=100) Manufacturing 109.5 109.7111.2110.2 110.3 115.0 113.8 114.7 Domestic 105.0 105.5104.9105.8 103.5 109.5 107.6 108.1 Foreign 113.1 113.1116.3113.8 115.8 119.5 118.9 120.2 Construction index (2010=100) 120.9 121.1126.1125.1 127.2 125.2 130.9 137.7 Housing permits issued ('000) 82.6 85.9 84.8 98.0 93.5 99.3 79.2 90.3 Retail sales (excl autos; 2010=100) 107.6 107.9108.5107.9 108.7 110.4 111.2 112.3 Foreign trade & payments ( bn) Exports fob 299.0 296.4297.9299.1 298.7 305.8 314.4 319.3 Imports cif - 239.7-236.7 - - -237.4-245.6-254.5-258.0 235.9233.6 Trade balance 59.3 59.8 62.0 65.6 61.2 60.1 59.9 61.3 Current-account balance 67.1 74.1 64.3 70.0 59.1 69.0 65.8 54.6 a Working-day adjusted. b Minimum bid rate for main refinancing operations. Sources: Bundesbank, Monatsbericht; OECD, Main Economic Indicators; Federal Statistical Office (Destatis).

Germany 12 Monthly data Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Exchange rate US$: (av) 2015 1.16 1.13 1.08 1.08 1.11 1.12 1.10 1.11 1.12 1.12 1.07 1.09 2016 1.09 1.11 1.11 1.13 1.13 1.12 1.11 1.12 1.12 1.10 1.08 1.05 2017 1.06 1.06 1.07 1.07 1.11 1.12 1.15 1.18 n/a n/a n/a n/a Exchange rate US$: (end period) 2015 1.13 1.12 1.08 1.12 1.10 1.12 1.10 1.12 1.12 1.10 1.06 1.09 2016 1.09 1.09 1.14 1.14 1.12 1.11 1.11 1.11 1.12 1.09 1.06 1.05 2017 1.08 1.06 1.07 1.09 1.12 1.14 1.17 1.18 n/a n/a n/a n/a Real effective exchange rate (2010=100; CPI-basis) 2015 95.0 94.1 92.4 91.8 92.7 93.2 92.5 94.0 94.5 94.3 92.6 93.4 2016 94.2 94.8 94.5 94.7 94.8 94.4 94.4 94.7 94.8 94.9 94.5 94.3 2017 94.3 93.9 94.1 93.9 95.0 95.7 96.6 n/a n/a n/a n/a n/a Deposit rate (av; %) 2015 0.5 0.5 0.4 0.3 0.4 0.3 0.3 0.3 0.3 0.3 0.3 0.3 2016 0.4 0.3 0.3 0.4 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.2 2017 0.3 0.3 0.3 0.2 0.2 n/a n/a n/a n/a n/a n/a n/a Lending rate (av; %) 2015 2.0 1.9 1.8 1.7 1.6 1.7 1.9 1.9 1.9 1.9 1.9 1.8 2016 1.8 1.8 1.7 1.7 1.6 1.6 1.6 1.5 1.5 1.5 1.4 1.5 2017 1.6 1.6 1.7 1.7 1.7 n/a n/a n/a n/a n/a n/a n/a Industrial production (% change, year on year) 2015-0.2-0.2 0.2 0.8 1.9 1.4 0.9 2.6 0.3 0.2-0.2-1.0 2016 2.2 1.8 1.0 0.9-0.4 1.1-1.3 2.5 1.8 1.7 2.6 0.0 2017-0.5 1.5 2.1 2.6 4.9 2.5 n/a n/a n/a n/a n/a n/a Retail sales, excl autos (% change, year on year) 2015 3.1 2.2 1.3 2.5 4.8 2.9 5.5 3.8 5.6 3.7 4.2 5.6 2016 4.8 3.8 2.1 2.3 1.0 1.5 1.2 1.4 0.5 3.3 1.7 2.0 2017 0.3 2.9 4.5 4.0 3.4 4.8 2.9 n/a n/a n/a n/a n/a DAX share price index (end-period; Dec 30th 1987=1,000) 2015 10,694 11,402 11,966 11,454 11,414 10,945 11,309 10,259 9,660 10,850 11,382 10,743 2016 9,798 9,495 9,966 10,039 10,263 9,680 10,338 10,593 10,511 10,665 10,640 11,481 2017 11,535 11,834 12,313 12,438 12,615 12,325 12,118 12,056 n/a n/a n/a n/a Consumer prices (av; % change, year on year) 2015-0.4 0.0 0.3 0.3 0.6 0.2 0.0 0.1-0.1 0.2 0.2 0.2 2016 0.5-0.1-0.1-0.1-0.1 0.2 0.4 0.3 0.6 0.6 0.7 1.7 2017 1.9 2.2 1.7 1.8 1.4 1.5 1.5 1.8 n/a n/a n/a n/a Producer prices, manufacturing (av; % change, year on year) 2015-2.1-1.8-1.5-1.4-1.3-1.4-1.4-1.7-2.0-2.2-2.4-2.2 2016-2.3-2.9-2.9-2.9-2.7-2.1-2.0-1.7-1.4-0.4 0.1 0.8 2017 2.3 3.0 2.9 3.2 2.7 2.2 2.1 n/a n/a n/a n/a n/a EU harmonised unemployment rate (seas adj; %) 2015 4.8 4.8 4.7 4.7 4.7 4.6 4.6 4.5 4.5 4.5 4.5 4.4 2016 4.4 4.3 4.3 4.3 4.2 4.2 4.2 4.1 4.1 4.0 4.0 3.9 2017 3.9 3.9 3.9 3.9 3.8 3.8 3.7 n/a n/a n/a n/a n/a Total exports fob ( bn) 2015 97.0 97.8 98.6 100.0 101.4 100.1 102.5 96.9 99.6 98.8 99.4 98.3 2016 98.3 98.9 100.7 100.6 99.3 99.2 97.6 101.0 100.0 100.6 103.6 101.5 2017 104.0 105.0 105.4 106.3 107.9 105.0 n/a n/a n/a n/a n/a n/a Total imports fob ( bn) 2015 76.5 77.5 79.3 79.3 79.7 79.1 80.6 78.4 80.7 78.7 79.6 78.4 2016 79.3 79.3 77.4 77.6 77.7 78.3 78.3 79.8 79.3 80.0 82.7 82.9 2017 85.1 83.8 85.6 86.5 87.6 83.8 n/a n/a n/a n/a n/a n/a Trade balance fob fob ( bn) 2015 20.4 20.3 19.3 20.8 21.7 21.0 21.9 18.5 18.9 20.1 19.8 19.9 2016 19.0 19.6 23.3 23.1 21.6 20.9 19.4 21.2 20.7 20.6 20.9 18.6 2017 18.9 21.1 19.8 19.8 20.3 21.2 n/a n/a n/a n/a n/a n/a Sources: IMF, International Financial Statistics; Haver Analytics.

Germany 13 Annual trends charts

Germany 14 Quarterly trends charts

Germany 15 Monthly trends charts

Germany 16 Comparative economic indicators Basic data Land area 356,970 sq km, of which 55% is agricultural land and 29% forest Population 81.9m (end-2015 estimate)

Germany 17 Main cities Population in 000 (end 2012) Berlin (capital): 3,375 Hamburg: 1,734 Munich (München): 1,388 Cologne (Köln): 1,024 Frankfurt am Main: 688 Stuttgart: 598 Climate Temperate Weather in Frankfurt (altitude 125 metres) Hottest month, July, 15 20 C (average daily minimum and maximum); coldest month, January, minus 1 3 C; driest month, February, 40 mm (average monthly rainfall); wettest month, June, 70 mm Language German Weights and measures Metric system Currency Euro ( = 100 cents) Time 1 hour ahead of GMT in winter, 2 hours ahead in summer Fiscal year January-December Public holidays January 1st (New Year's Day), April 14th (Good Friday), April 17th (Easter Monday), May 1st (Labour Day), May 25th (Ascension Day), June 5th (Whit Monday), June 15th (Corpus Christi), October 3rd (Reunification Day), December 25th and 26th (Christmas); additional public holidays apply for various states

Germany 18 Political structure Official name Bundesrepublik Deutschland (Federal Republic of Germany) Legal system

Germany 19 Based on the Grundgesetz (Basic Law) of 1949 Unification The states (Länder) of the former German Democratic Republic (East Germany) acceded to the Federal Republic on October 3rd 1990 National legislature Bicameral parliament. Bundestag (lower house), currently with 631 members (299 directly elected from individual constituencies; 332 through party lists in each state, so as to obtain proportional representation). Parties must win at least 5% of the national vote, or three constituency seats, to gain representation. The Bundesrat (upper house) comprises members nominated by 16 state governments; there is currently a centre-left majority National elections Next federal election set for September 24th 2017; next presidential election in 2022 Head of state Federal president, elected for a maximum of two five-year terms by the Federal Assembly, consisting of members of the Bundestag and representatives of the state legislatures. Largely a ceremonial role. Frank-Walter Steinmeier (SPD) was elected on February 12th 2017 State legislature Each state has an elected legislature. State governments and parliaments have considerable responsibilities, including education and policing National government The federal government is led by the chancellor, who is elected by the Bundestag on the nomination of the federal president. The leader of the centre-right Christian Democratic Union (CDU), Angela Merkel, is currently serving her third term as chancellor. Following the general election in September 2013, the CDU, the CDU s Bavarian sister party, the Christian Social Union (CSU), and the centre-left Social Democratic Party (SPD) formed a grand coalition government in December 2013, replacing the previous centre-right coalition of the CDU/CSU and the pro-business Free Democratic Party (FDP) Main political parties Christian Democratic Union (CDU); its sister party, the Christian Social Union (CSU); Social Democratic Party (SPD); Left Party; Alliance 90/The Greens; Free Democratic Party (FDP); Alternative for Germany (AfD) Key ministers Chancellor: Angela Merkel (CDU) Vice-chancellor & foreign affairs: Sigmar Gabriel (SPD) Defence: Ursula von der Leyen (CDU) Economic co operation & development: Gerd Müller (CSU) Economics & energy: Brigitte Zypries (SPD) Education & research: Johanna Wanka (CDU) Environment, nature conservation building & nuclear safety: Barbara Hendricks (SPD) Family affairs, senior citizens, women & youth: Manuela Schwesig (SPD)

Germany 20 Finance: Wolfgang Schäuble (CDU) Food & agriculture: Christian Schmidt (CSU) Health: Hermann Gröhe (CDU) Interior: Thomas de Maizière (CDU) Justice & consumer protection: Heiko Maas (SPD) Labour & social affairs: Andrea Nahles (SPD) Special tasks & head of federal chancellery: Peter Altmaier (CDU) Transport & digital infrastructure: Alexander Dobrindt (CSU) President of the central bank Jens Weidmann

Germany 21 Recent analysis Generated on September 27th 2017 The following articles were published on our website in the period between our previous forecast and this one, and ser a review of the developments that shaped our outlook. Politics Forecast updates August 23, 2017: International relations Tensions between Turkey and Germany escalate Event On August 18th the Turkish president, Recep Tayyip Erdogan, urged Turks in Germany not to back any mainstream parties, including Angela Merkel's Christian Democratic Union (CDU), at the German federal election on September 24th. Mr Erdogan's remarks are the latest in a war of words that has led to a deepening crisis in Turkey's relations with Germany and the wider EU. Analysis Mr Erdogan's statement followed recent remarks by Ms Merkel in which she stated that she was opposed to calls to end Turkey's EU membership negotiations, but that Germany would pressure the European Commission to reduce EU funds to Turkey and halt plans to enhance the customs union agreement between Turkey and the EU. Germany had previously angered Mr Erdogan by rejecting Turkey's extradition requests for those accused of involvement in the failed coup in July 2016 and refusing to allow Turkish ministers to address rallies in Germany during Turkey's presidential reform referendum campaign in April 2017. Turkey, for its part, has prevented German parliamentarians from visiting German troops stationed at the Incirlik air base in Turkey, and refused to release a German- Turkish journalist and a German human rights campaigner arrested in Turkey on terrorist charges under emergency rule. At one level, the feud between Mr Erdogan and Ms Merkel is simple politics. Ms Merkel is seeking re-election and wants to bolster her democratic credentials by standing up to authoritarian leaders such as Mr Erdogan. Mr Erdogan wants to shore up his domestic public support, which he has consistently done by vilifying Western leaders as imperialist and/or anti-muslim if they criticise his government. There is a risk that the recent tensions will damage Turkey's relations with Germany and the EU beyond repair. However, following the expected re-election of Ms Merkel, we expect the two leaders to seek to defuse tensions. Ms Merkel still appears convinced that the Turkey-EU agreement reached during the migrant crisis is useful in stemming the flow of migrants through Greece to Europe. We also expect that the two leaders will seek to move forward in a limited number of areas that they can agree upon. Despite Ms Merkel's rhetoric, a revision of parts of the customs union agreement may be one of those areas. Impact on the forecast We maintain our political and international relations forecast that neither Turkey nor the EU is genuinely interested in Turkish membership of the bloc, but that neither is willing to end the negotiations unilaterally.

Germany 22 Analysis August 11, 2017: Election watch The inevitable chancellor s new coalition The main question ahead of the federal election on September 24th is not who will win the largest share of the vote, but which party or parties will join the probable winner, the Christian Democratic Union (CDU), in forming a coalition, with the current chancellor, Angela Merkel, again at the helm. Current polls suggest that the CDU could have its pick of a single smaller party, either The Greens or the liberal Free Democratic Party (FDP), or form a coalition with both. It could also form another grand coalition with the centre-left Social Democratic Party (SPD). As the margins are likely to be small, it remains impossible to say which exact coalition will emerge, although we believe another grand coalition to be unlikely, in part because the SPD will be hesitant to enter into another one. For domestic policy the differences will be limited. However, the smaller parties have considerably different views on reform of the euro zone. We expect this to factor into Ms Merkel's considerations for her choice of coalition partner, but it could also prove a brake on euro zone reform in the coming years. Opinion polls have in recent months moved decisively in favour of Ms Merkel, both for her party and her personal approval rating. With the gap between the CDU and the SPD at around 14 percentage points just seven weeks before the election, it is increasingly likely that the CDU will win the largest share of the vote. Ms Merkel has captured most of the middle ground in a country that has enjoyed several years of economic stability and growth, with a recent poll showing that 81% of the electorate are happy with their own economic situation a historical high. She has thereby turned herself and her party into the default option for a large part of the electorate, who would clearly prefer stability to a shake-up of the apparently satisfying status quo. This has made it difficult for any challengers to come up with a platform on which to oppose her, especially now that the political salience of the refugee issue has diminished, as inflows have returned to normal levels after spiking during the European migrant crisis in 2015 16. Martin Schulz, the former president of the European Parliament who took over the leadership of the SPD in early 2017, has evidently been found lacking in this regard by the German electorate. Following a short period of hype after his arrival on the domestic political scene as he had spent most of his career in Brussels, he was largely unknown in Germany both his personal approval ratings and his party's poll ratings have fallen back to only just above where they were at the end of 2016. His emphasis on social justice and on rolling back many of the labour market reforms that many Germans credit with the country's recent economic success has not captured the electorate's imagination. That the SPD seems not to have changed its election strategy since then, building its campaign so far around Mr Schulz and emphasising the same issues, has in our view made it even more unlikely that the SPD will pose a serious threat to the CDU.

Germany 23 The most interesting question that will be answered in the election is how the smaller parties will fare, as this will determine the type of coalition that will emerge. All of the smaller parties that are likely to cross the 5% electoral threshold the FDP, The Greens, the Left Party and the far right, populist Alternative for Germany (AfD) are polling at around 8%. We expect all four parties to win between 6% and 10% of the vote. However, the exact number of seats that they manage to win will be crucial for the subsequent coalition talks, as this will determine the number of parties needed for a CDU-led majority coalition. Domestic policy stable, movement on euro zone reform possible Assuming that the CDU wins the largest share of the vote, it will be first in line to try to form a coalition. The SPD would be highly unlikely to take the lead in forming a government in this event, as the three left-wing parties would almost certainly fall short of a majority of seats in the Bundestag (the lower house of parliament), and in any case the SPD remains hesitant to work with the Left Party (the hard-left successor to East Germany's communist party). We see four possible CDU-led coalitions after the election. Current polls suggest that it will be close as to whether the CDU and its Bavarian sister party, the Christian Social Union (CSU), will be able to form a coalition with just one of the smaller parties or whether they will need two. With six weeks to go before the election, Ms Merkel has not been in full campaign mode yet and when she is she will be able to reinforce her image of competence and stability. Furthermore, we see little risk of any significant disrupting events. We therefore believe that there is some upside risk to the CDU's eventual vote share, making a two-party coalition without the SPD more likely to be possible. The different coalitions would implement different domestic policies, for instance regarding the balance between tax cuts and additional public investment the large fiscal surpluses in recent years have led to a broadly shared understanding that fiscal room has opened up but we expect the differences to be relatively modest. A CDU-Green coalition would enact more green policies, for example expediting the closure of coal-fired power plants, and the FDP would demand large tax cuts. However, in part given the satisfaction with the status quo we would not expect any party to push for a large-scale reform effort. The major question of interest will be to what degree Germany will be willing to work together with France to reform the institutions of the euro zone and, for instance, set up a European Monetary Fund. The CDU-CSU's choice of coalition partner or partners will have large influence on this although Germany will in any case only agree to increased risk sharing if it is accompanied by increased oversight of national economic and budgetary policies.

Germany 24 Some coalitions would be less willing to work with the French president The most natural ally for the CDU, based both on historical experience and overlap in election programmes, would be the FDP, with which Ms Merkel formed her second coalition government in 2009 13. The FDP would also be by far the preferred partner for the CSU, which tends to be slightly to the right of the CDU, especially under Ms Merkel. Although the FDP has been at pains to declare that it does not plan to enter government after the election, this is likely to be political posturing to make sure that potential voters do not defect to the CDU. However, the FDP has taken a hard line on European issues, including against many of the reforms suggested by the new French president, Emmanuel Macron. Senior CDU figures, including Ms Merkel and the notoriously hardline finance minister, Wolfgang Schäuble, have already expressed a willingness to implement reform of the euro zone, including possibly more risk pooling. The CDU's willingness to move on this issue is visible in one of its campaign slogans, which claims that "strengthening Europe means strengthening Germany". The FDP would thus present a significant barrier to implementing the kind of reform that Ms Merkel might see as the crowning achievement of her decade-and-a-half chancellorship, or simply as a necessary step for the EU and the euro zone. The second option would be a CDU-Green coalition. Although we do not have any privileged insight into Ms Merkel's thinking, we would expect this to be her preferred coalition partner. She has gravitated towards The Greens in recent years in policy terms, if not in outcomes then at least in perceptions among the voting public. In its election programme the CDU opened up this option by arguing for the medium- to long-term abolition of coal-fired power plants, one of the few hard requirements for The Greens for participation in government. The Greens have embraced the agenda set out by Mr Macron and would therefore not be a hindrance to euro zone reform efforts. Furthermore, this would allow Ms Merkel to sideline those forces within the CDU opposed to reform of the euro zone, which are sizeable and could in themselves threaten these efforts given the need for consensus in the German political system. A coalition between the CDU, the FDP and The Greens (referred to as the Jamaica coalition in reference to the parties' colours matching the Jamaican flag) would come into view if the CDU and either The Greens or the FDP would not have a majority together, or if the majority would be prohibitively small. Coalition negotiations would be significantly more difficult in such a case, as The Greens and the FDP are far apart on several issues although such a coalition was recently agreed in the state of Schleswig-Holstein. This would also create a more complicated picture for euro zone reform, but given the balance within the coalition we would expect an outcome closer to that of a CDU-Green coalition than one with the FDP.

Germany 25 The final realistic option would be for another grand coalition, which would be the third one under Ms Merkel. Despite some rumblings from CDU and SPD officials that they do not want to embark on another grand coalition, the election programmes presented by both parties remain close enough that they could come to a credible coalition agreement. However, although the CDU would probably be amenable to continuing with the current coalition, this would make it difficult for the SPD to differentiate itself from the CDU, and we would expect the party to be hesitant for this reason. On the domestic front such a coalition would probably lead to a continuation of the current bargaining between the two parties. As they are relatively well-aligned on EU and euro zone issues, this combination would guarantee strong German support for reforms of the euro zone. August 25, 2017 Building a stronger Europe takes centre stage Germany's foreign policy has seen a shift in emphasis since the actions in Ukraine of Vladimir Putin, the Russian president, and the election of Donald Trump as US president. Building a strong Europe, and in particular a strong Franco-German partnership, is now a priority, in order to confront uncertainty elsewhere. There is an increasing amount of discussion around a multi-speed Europe, with integration progressing at different speeds for different groups of countries. The more positive economic context and more threatening geopolitical environment are supporting Germany's greater openness to more integration in Europe. German foreign policy is currently in a transitional period, reflecting a significant degree of change both in Europe and elsewhere in the world. The UK's vote to leave the EU, the failure of the European Commission's burden-sharing agreement following the migrant crisis in 2015 and the challenges posed to the bloc's values system by the governments in Hungary and Poland have given the impression of a fragmenting European community. Meanwhile, further afield, the actions of Mr Trump and Mr Putin are serving to undermine the global rules-based order that Germany has always held as the gold standard and are making clear that defence capabilities, and not just soft power, will be required in the coming years. In the wake of Mr Trump's election last year media outlets were quick to proclaim Angela Merkel, the German chancellor, the new "leader of the free world", marking a step up from her de facto leadership of the euro zone during the bloc's sovereign debt crisis. Ms Merkel, however, was circumspect in her response. Given Germany's role in European history, its already oversized political clout in the region and the largest economy in the euro zone, as well as the financial outlay that shouldering a global leadership role would entail, Ms Merkel has been extremely hesitant to take on this role. At the same time the various threats posed by Mr Trump and Mr Putin, as well as potential flashpoints elsewhere in the world notably the Gulf region and North Korea have made the need for strong European leadership increasingly pressing. In this context the election of Emmanuel Macron as French president came as a relief. Mr Macron campaigned on the promise of a stronger EU and a more integrated euro zone, and his actions since taking office have shown that he also intends to assert himself on the international stage. Germany has long-standing concerns about French desires for greater risk-sharing in the euro zone, which the public typically interprets as being required to bankroll more profligate neighbours, and does not intend to make any compromises until France raises its growth rate and narrows its fiscal deficit. Nonetheless, a more balanced Franco-German partnership is in both countries' interests, and Ms Merkel has so far appeared cautiously receptive to Mr Macron's proposals for euro zone reform.

Germany 26 Favourable context for euro zone reforms Mr Macron's proposals hinge on the creation of a common euro area budget for joint investment projects, responding to economic shocks and emergency financial assistance to be handled by a euro zone finance minister. Mr Macron and Ms Merkel seem to be in agreement that these and other plans for greater integration could be undertaken by "flexible constellations" of euro zone members on an opt-in basis comparable to the steps taken by a subset of EU countries to move forward on greater defence integration. Long-standing concerns about whether the creation of a multi-speed Europe would lead to disintegration are being superseded by a sense that building confidence in the bloc will only be possible by achieving solid results, and that allowing flexibility on who enters different projects is the best way to demonstrate the advantages of membership. Whether such plans prove practicable remains to be seen, but the will to try is now apparent. How far Germany is willing to go in reforming the single currency area will depend on the results of the September 24th general election. We expect Ms Merkel to win a fourth term as chancellor, but her room for manoeuvre will depend on which party (or parties) her Christian Democratic Union (CDU) is able to form a coalition with. The liberal Free Democratic Party (FDP), for instance, would be less receptive than The Greens or the Social Democratic Party (SPD) to further euro zone integration. Nonetheless, there has been a shift in the political messaging on this topic in recent months, with Ms Merkel sounding a much firmer note about the necessity of euro zone reform. In part, this reflects the change in the geopolitical context and the greater awareness of external threats against which Europe needs to protect and define itself. Ms Merkel's sense that the UK, the US and Russia are no longer reliable partners on the global stage is a driver of her desire for a strong Europe, and in particular a strong Franco-German relationship. However, her greater openness to reform also reflects the improvement in the economic context. With the euro zone experiencing a robust cyclical upturn and Germany on track to record its fourth consecutive budget surplus this year, there is now more money to play with, making ambitious reforms more feasible. Defence spending to remain controversial One of the most prominent foreign policy issues in the election campaign will be defence spending. Mr Trump has criticised his European NATO allies for not spending enough, and this has posed a particular dilemma in Germany, where there is a deep-seated, historical distrust of military institutions and a reluctance to reverse the post-war demilitarisation. Ms Merkel has pledged to increase German spending on defence, from 1.2% at present to the NATO target of 2% by 2024, but the SPD objects to this and has sought to present her decision as pandering to Mr Trump. Raising EU defence spending and co-operation is less controversial, however, with all of the mainstream German parties in favour and the economic context increasingly favourable. The role that greater military investment might play as a stimulus programme is a further point in its favour. Having a military force that can act as a credible deterrent at the centre of Europe is considered more important by European policymakers in the wake of Russia's annexation of Crimea in 2014. Germany had enjoyed decades of comparatively good relations with Russia prior to this, building partnerships in areas such as energy and education, and encouraging modernisation. However, Germany is also a strong believer in the rules-based international order, and Russia's actions in Ukraine were a flagrant violation of this. In response, Germany became one of the strongest EU proponents of sanctions on Russia in 2014 and has remained so ever since. Pragmatic co operation between the countries will continue especially on energy but the threat of a military accident on the border of a NATO state, an escalation of the conflict in Ukraine or further Russian cyber-attacks in Europe makes Germany now a more circumspect partner. Continued co-operation, albeit on a deeper level than with Russia, will also be

Germany 27 Germany's strategy for dealing with the US. The US is, and will remain, Germany's largest export market outside the EU and its most important non-eu partner on the international stage. Calls for Europe to raise its defence spending predate Mr Trump's presidency, as does the US's broader disengagement from Europe as a focus of foreign policy, which began with the previous administration's "pivot to Asia". The US's gradual withdrawal from its global leadership role is a further driver of greater German and EU foreign policy heft and more serious investment in defence capabilities. In the short to medium term Europe will continue to rely on the US's military might for Europe's defence. In the longer term, however, Ms Merkel is looking to build a much stronger and more independent Europe. Economy Forecast updates August 11, 2017: Economic growth Unemployment remained at post-reunification low in July Event In July total unemployment fell to a seasonally adjusted 2.54m, down by 9,000 from the previous month, according to data released by the Federal Employment Agency. The unemployment rate remained at 5.7% (national measure), a post-reunification low, down by 0.4 percentage points year on year. Analysis The July data continue positive recent trends that have contributed to the further strengthening of the German labour market on the back of robust economic growth. Most of Europe is experiencing a sustained cyclical upswing, with demand in both Germany and many major trading partners rising. Germany's manufacturing purchasing managers' index (PMI) survey data for July showed continued strong job growth in the sector on the back of robust demand. Seasonally adjusted unemployment has fallen by 92,000 since the beginning of the year, significantly higher than the 52,000 drop recorded in the first seven months of 2016. Labour shortages have long been reported in particular sectors and regions. The Federal Employment Agency reported that job vacancies rose to 750,000 in July, up by 76,000 from June. The fact that unemployment is continuing to decline is particularly noteworthy in the context of large numbers of new entrants to the labour market, including from lower-

Germany 28 income EU members in southern and eastern Europe and the large inflow of refugees from the Middle East in 2015-16. The inflow of Middle-Eastern refugees in particular could pose a challenge in the medium term, as many have low skill levels. As many are currently undergoing lengthy asylum application processes, in the coming years a larger number of refugees will formally join the labour force. This will lead to a fairly sharp expansion of the labour supply and is likely to limit a further drop in the unemployment rate. Further strong employment growth looks likely. As a lagging indicator, employment will continue to benefit from the current strong momentum in the economy. Secondquarter GDP growth (for which a flash estimate will be published on August 15th) is likely to have been strong, and many measures of economic sentiment are at or close to multi-year highs. The European Commission's employment expectations indicators for industry, services and retail trade all rose in July, with the indicator for services (which represents by far the largest share of employment) at a post-crisis high. Impact on the forecast The latest data are in line with our forecast that the EU-harmonised unemployment rate will average 3.8% this year, down from 4.2% in 2016. August 14, 2017: Economic growth Industrial output fell in June Event In June seasonally and working-day-adjusted industrial output fell by 1.1% month on month, after expanding by 1.2% in May. In year-on-year terms, working-dayadjusted output rose by 2.4%. For the second quarter as a whole, output was up by 1.8% relative to the previous three months. Analysis In working-day-adjusted terms, annual output growth in June was half that in May. The slowdown to a 2.4% headline rate of expansion was caused by lower growth in most major production categories. Output of consumer goods rose by 1.9% year on year, slowing from 3.3% in the previous month, driven by a sharp slowdown in durable consumer goods production (+2.4% in June, from +10.7% in May); output of motor vehicles fell by 3.3% year on year, after an 8.3% rise in May. Meanwhile intermediate goods output rose by 2.8%, slowing from 3.8% in May, and production of capital goods increased by 1%, slowing from 6.6%. The slowdown from May is clear in the June data, but the impression remains that

Germany 29 the industrial sector, like much of the rest of the economy, is growing strongly. May was an exceptionally strong month, but growth overall was good in the first half of the year. Output expanded by an average 2.2% year on year in January-June, and on a 12 month moving average basis is running at 1.6% the strongest rate since January 2015. Output has been propelled higher by a cyclical upswing across the euro zone, with higher confidence among consumers and businesses both at home and abroad leading to increased demand for German capital and durable consumer goods. Industrial output is likely to continue to expand at a healthy rate in the coming quarters. Sentiment is strong, with many indicators at or close to multi-year highs. The Ifo index recently reached its highest level since reunification. Meanwhile the domestic political backdrop is stable, with the upcoming federal election in October largely notable for its lack of excitement. New manufacturing orders rose by 5.1% year on year in June a six month high. One risk is the ongoing scandal surrounding Germany's carmakers, relating to diesel emissions rigging. The EU recently launched a cartel investigation into the German car industry, on top of an existing legal action against the country for failing to enforce emissions limits on diesel cars. Impact on the forecast We intend to revise up our forecast for industrial output growth in 2017, to 2.3%, from 1.8%. August 15, 2017: Economic growth GDP grows by 0.6% in Q2 Event In the second quarter seasonally and working-day-adjusted real GDP expanded by 0.6% quarter on quarter, according to data released by the Federal Statistical Office (Destatis). Year on year, the economy expanded by 2.1%. First-quarter growth was revised up to 0.7% quarter on quarter, from 0.6% previously. Analysis A full breakdown will be released on August 25th, but in its initial press release Destatis noted that growth was driven primarily by domestic demand, with both households and the government increasing their consumption. Investment also continued to support growth. In part owing to a small housing boom annual house price growth has averaged almost 6% since the start of 2016 construction continued to rise, following a robust quarterly increase of 2.3% in the first quarter. Investment in equipment by businesses grew for a second consecutive quarter, after having recorded three quarters of consecutive quarterly contractions in 2016, suggesting that the more positive economic outlook for Germany and the euro zone is feeding through into businesses' willingness to expand capacity. Nevertheless, the external balance was a drag on growth, as strong domestic demand led to import growth significantly outpacing export growth.

Germany 30 At the start of the third quarter most sentiment indicators indicated a slight softening of recent positive momentum. In line with this, we expect the expansion to continue in the final two quarters of the year, but at a slightly more moderate pace. Strong employment growth, at 1.5% year on year in the second quarter, and only moderate inflation, helped in part by a slight strengthening of the euro, will support further private consumption growth. Investment will be supported by continued business investment and construction, with activity in these sectors accelerating further in July, according to the construction purchasing managers' index released by IHS Markit. Continued growth in demand from many of Germany's most important export markets in the euro zone, supported by an uptick in the French economy, should maintain export growth. However, as strong domestic demand is likely to continue to push up imports, the contribution to growth from the external balance will be limited or even negative. Impact on the forecast The strong GDP figures for the first half of 2017 are likely to lead to a small upward revision to our forecast for full-year average real GDP growth, from 1.9% currently to 2%. August 16, 2017: Economic growth Euro zone GDP up by 0.6% in Q2 Event According to a flash estimate of real GDP from Eurostat, the euro zone economy grew by a quarterly 0.6% in the second quarter of 2017. Year-on-year growth accelerated from 1.9% in the first quarter (revised up from 1.7%) to 2.2% in the second (revised up from 2.1%), the fastest since the first quarter of 2011. Analysis The aggregate data follow a series of country-level releases in recent weeks, many of which were firmer than anticipated. This has already prompted upward revisions to our forecasts for real GDP growth in France and Spain, while more recent data for Germany and, in particular, the Netherlands, also showed a robust pace of expansion that will prompt similar adjustments to our forecasts. Having first started to gather momentum in 2015, the latest data confirm that economic growth in the euro zone has not only strengthened in the first half of 2017, but has also broadened, with 14 out of the 19 economies recording year-on-year growth rates of above 2% in the second quarter. This compares with the first quarter

Germany 31 of 2016, when only six economies grew by more than 2%. Even of the laggards in 2017, growth in Belgium, Italy, France and Finland was still firm, at 1.4 1.7%, while Greece remains the outlier. Export data show that external demand within the region has picked up in recent quarters, but the euro zone's recovery since 2014 has largely been driven by domestic demand as looser monetary policy has boosted credit growth, and confidence and labour market conditions have improved. The aggregate unemployment rate fell to 9.1% in June, which was 1.8 percentage points above the pre-crisis low, but still the lowest since February 2009. However, the labour market data betray a more persistent imbalance than that implied by the headline growth rates, with the unemployment rate in Germany and the Netherlands at 3.8% and 4.9% respectively. In France and Italy it is closer to 10 11%; it remains high at above 17% in Spain and almost 22% in Greece. In the near term at least, we expect this and other regional imbalances to constrain a rapid acceleration in the expansion of the euro zone economy. Impact on the forecast The second-quarter data raise the upside risks to our forecast for euro zone real GDP growth of 2% in 2017, after 1.8% growth in 2016. This forecast assumes a slight moderation in the pace of expansion in the second half of the year. August 16, 2017: Inflation EU harmonised inflation unchanged at 1.5% in July Event Consumer price inflation on the national measure reached 1.7% in July, up from 1.6% in June, according to a final release by the Federal Statistical Office (Destatis). Germany's EU harmonised index of consumer prices (HICP) rose by 1.5% year on year in July, the same rate as in June. In the year to date, inflation on the HICP measure has averaged 1.7%. Analysis The breakdown of inflation on the national measure in July indicates similar trends to June, with inflation having eased in recent months as energy base effects have become less supportive. Prices rose by an average of 1.9% in January-April, driven by strong growth in the transport category, which is heavily influenced by energy prices. In May-July average inflation on this measure slowed to 1.6% as year-onyear energy price growth eased. Euro-denominated pump prices for unleaded petrol

Germany 32 rose by an average of 13% year on year in January-April, but by just 2% in May- July. Although energy price growth has slowed substantially, some domestic sources of price growth have firmed. Rent, water, electricity, gas and other fuels prices rose by 1.5% year on year in July, up from 1.3% in June. The rental component has risen particularly strongly in recent months, reflecting growing pressures in the housing sector driven by a pick-up in population growth. Meanwhile, the cost of food and non-alcoholic beverages rose by 2.6% year on year in July, unchanged from the previous month but still comparatively robust, with continued strong growth in dairy prices (up by 14%). Prices in the recreation and culture category rose by 2.2% in July, a slight moderation from the 2.5% growth recorded in June. We expect inflation to remain around its current level throughout our forecast period (2017 21). Even with the economy close to full employment, a positive output gap and some sentiment indicators at post-reunification highs, core inflation on the EU harmonised measure remains below 2% (it reached 1.8% year on year in June latest available data). The strong euro, and its negative impact on import prices, subdued global energy prices and the likelihood of fairly weak nominal earnings growth (at least in the context of the strength of the labour market) will keep inflation fairly subdued. Impact on the forecast The latest data are in line with our forecast that EU harmonised inflation will average 1.6% this year. August 29, 2017: Economic growth Composite PMI ticks back in August Event Business surveys continued to indicate resilient private-sector output growth in August. The flash composite purchasing managers' index (PMI) strengthened after a modest dip in July, and the Ifo business climate index remained virtually unchanged near the historical high reached in July. Analysis The composite PMI for Germany covering the manufacturing and services sectors registered 55.7 in August (above 50 implies a rise in private sector output), up from a ten-month low of 54.7 in July. This was a strong performance by historical standards and in line with the healthy trend over the past year, underpinned by solid

Germany 33 production, new orders and employment growth. However, the composite PMI remained slightly below its second-quarter average of 56.8, and the "future output" component eased slightly for a third successive month, implying a mild softening of momentum in the current quarter. The survey data continued to indicate a much faster pace of expansion in Germany's large export-oriented manufacturing sector than in private-sector services. In August the manufacturing PMI strengthened by 1.3 points, to 59.4, close to the recent sixyear high of 59.6 in June, buoyed by a firmer trend in new order growth particularly among goods producers exporting to Asia and outstanding business. Manufacturers reported a rise in capacity pressures, mainly via a lengthening of suppliers' delivery times, and an upturn in input cost inflation, although price growth remained softer than in the opening months of 2017. The services PMI component also improved in August, albeit only slightly, by 0.3 points, to 53.4, implying a continuation of moderate output growth across the sector. This compared with a recent high of 55.6 in March. Quarterly real GDP growth averaged 0.7% in the first two quarters of 2017, and the July and August sentiment data point to continued growth in the third quarter, albeit at a slightly reduced pace. This is also supported by the expectations indicator in the ZEW financial market survey of economic sentiment, which although it has a weaker record than the PMI and Ifo data in foreshadowing German real GDP growth declined sharply by 7.5 points, to 10, the third successive monthly fall and well below its long-term average of 23.8. Impact on the forecast The robust August sentiment readings mean that we are likely to make a slight upward revision to our forecast for full-year real GDP growth in 2017, from 1.9% currently. September 4, 2017: Economic growth Schulz fails to reboot campaign in debate Event On September 3rd the first and only election debate between Angela Merkel, the lead candidate for the Christian Democratic Union (CDU), and Martin Schulz, of the Social Democratic Party (SPD), took place. Polls released after the debate showed that over half of voters thought Ms Merkel had been the most convincing candidate, compared with only just over a third for Mr Schulz.

Germany 34 Analysis The debate was broadly seen as Mr Schulz's last chance to regain ground against Ms Merkel, with the SPD trailing the CDU in the polls by around 14 percentage points in the weeks leading up to the debate. However, Mr Schulz failed to land any crucial points against Ms Merkel in a rather sedate debate. In fact, Mr Schulz spent most of his time agreeing with the chancellor although she made sure not to be seen returning the compliment. In line with Ms Merkel's traditional strategy of "asymmetric demobilisation", namely discouraging potential voters for her opponent from coming out to vote, she managed to cover the entire middle ground, while at the same time coming across as more competent and up to the task of dealing with global threats, such as North Korea and a US retreating from global leadership under its current president, Donald Trump. Notably absent from the debate were significant discussions of domestic policy issues. The first hour of the 90 minute debate was spent on topics such as migration, the role of Islam in German society, relations with Turkey and foreign policy. Arguably the only remarkable statement came when relations with Turkey were discussed, when Ms Merkel stated that Turkey should not become an EU member. In 2013 Ms Merkel's SPD challenger, Peer Steinbrück, received a small bump in the polls following the debate. Although this is again a possibility, as polls showed that Mr Schulz did manage to outperform low expectations, we expect this effect to be fleeting at best. The debate highlighted how the grand coalition is problematic for the SPD, with Ms Merkel countering any critique of her policies by reminding viewers that the CDU and the SPD had made these decisions together. We therefore continue to expect the SPD to be hesitant to enter into another grand coalition following the election on September 24th. Impact on the forecast Ms Merkel's comfortable win in the debate strongly supports our forecast that the CDU will win the largest share of the vote in the election.

Germany 35 September 6, 2017: Economic growth Trend in retail sales remains strong in July Event Retail sales volumes (excluding motor vehicles and adjusted for seasonal and calendar variations) fell by 1.2% on a monthly basis in July, largely reversing a rise in June, according to data from the Federal Statistical Office (Destatis). Volumes were a solid 2.9% above their year-earlier level. New-car sales rose by 3.5% year on year in August as consumer sentiment remained at an elevated level. Analysis On an unadjusted basis, retail trade turnover (in real terms) rose by 2.7% year on year in July and by 4.2% in value terms, continuing the positive underlying trend in sales activity. Over the first seven months of 2017 real retail trade was on average 2.5% above its year-earlier level, marginally weaker than full-year growth of 2.7% in 2016. In seasonally and working-day-adjusted terms, however, real retail trade in January-July 2017 was up by a stronger 3.2% year on year. Furthermore, on a 12 month moving average basis, retail sales volumes growth (adjusted) was a robust 3.7% in the three-month period to July, a faster pace of underlying expansion than in 2016. Retail trade growth since the start of 2017 has been driven in particular by non-food sales (up by 3.6% year on year; unadjusted), which have outpaced growth in food volumes (up by 1.8%). Demand has been particularly strong in the category of furnishings, domestic appliances and building supplies, with sales 3.7% higher against a backdrop of robust construction activity and the broad upturn in the German housing market. Online and mail-order sales in January-July were 9% above their year-earlier level, underlining the continued pressure on more traditional retailing formats. The outlook for retail spending remains healthy, with employment and nominal wages rising steadily and borrowing costs still muted. The GfK forward-looking consumer climate indicator rose to a record-high 10.9 (percentage balance of positive and negative responses) for September. Two of the three sub-components of the index income expectations and propensity to buy improved from recent months, but there was a dampening of economic expectations, which eased lower for the first time in six months. Impact on the forecast The strong retail trade data in recent months will, together with strong private consumption growth on the national accounts in the second quarter, lead to a significant upward revision of our private consumption forecast for full-year 2017, currently at 1.5%. September 7, 2017: Monetary policy outlook Draghi lays groundwork for QE tapering Event The European Central Bank (ECB) kept its policy stance unchanged in September. Discussions are being held on the future of its quantitative easing (QE) programme, under which asset purchases are continuing at 60bn per month until end 2017. Analysis The policy announcement this month initially looked as though it would contain little new information, with the press statement identical to the one in July, including

Germany 36 a dovish warning that the ECB would increase the size and duration of QE if the euro zone outlook became "less favourable". However, in the press conference the ECB president, Mario Draghi, revealed that "very preliminary" discussions had taken place on how the bank would "calibrate" the programme beyond this year, and that he expected to be able to make an announcement on this in October. He also announced new staff forecasts, which contained an upward revision to euro zone GDP growth in 2017, from 1.9% to 2.2%. Analysis The mix of signals caused significant currency volatility in the euro, which had appreciated sharply against the dollar before the announcement, but weakened in response to the press statement, and then strengthened more decisively after Mr Draghi's news on QE discussions at the ECB, which included the "pros and cons" of options relating to the "length and size" of the programme. Mr Draghi's wording on this was deliberately vague, but given evidence of a stronger and broader economic recovery and a pick-up in underlying inflation it was widely interpreted in currency markets as a discussion on winding down (or "tapering") the pace of purchases. There are reasons for the ECB to remain cautious. A further rapid appreciation in the euro could yet weigh on inflation, having already prompted the bank to cut its inflation forecasts for 2018 and 2019, by 0.1 percentage point each, to 1.2% and 1.5% respectively. This will mean that asset purchases are tapered at a very gradual pace, and possibly that tapering may not begin in January 2018. Mr Draghi dismissed concerns about the supply of bonds to purchase, noting that the ECB had coped with scarcity concerns before, by which he referred to its decision in December 2016 to tweak the eligibility criteria. Impact on the forecast We no longer expect the bank to delay an announcement on QE tapering to December, but continue to expect that tapering will get underway in 2018 and that the main policy interest rate (currently at 0.5%) will be left unchanged in 2017 21. August 16, 2017 EIU global forecast - The global economy is in a sweet spot As 2017 has progressed it has become clear that the global economy is strengthening. Three interest-rate rises in the past eight months by the Federal Reserve (Fed, the US central bank), faster inflation in major economies, higher manufacturing purchasing managers' indices and falling unemployment rates in

Germany 37 the developed world are all indicators of a likely acceleration in economic growth in 2017. The big concerns about the global economy in recent years falling commodity prices, deflation, negative government bond yields and overly restrictive fiscal policies have all become less apparent. Consequently, The Economist Intelligence Unit expects the world economy to expand by 2.8% in 2017, compared with a lacklustre 2.3% in 2016. There are, nevertheless, caveats to this positive story. The world's leading economies are at very different points of their business cycles, meaning that the current pace of growth is unlikely to last for long. We consider China to be the furthest through its expansion phase: there is evidence of capacity constraints in some sectors, and the government is tightening monetary policy through a gradual curbing of credit growth. In the US, the Fed is accelerating the pace of its interestrate increases to combat an expectation of faster inflation and wage growth. The expansion in Europe is less well advanced. Although we have again revised our 2017 GDP growth forecast for the euro zone this month, to 2% from 1.9%, the regional economy is still in recovery mode. Unemployment in the euro zone is at its lowest since early 2009 but remains high compared with the rest of the developed world (and compared with levels before the global financial crisis), and there is little pressure on wages. Deflation is still a cause for concern in Japan, and, among emerging markets, Brazil and Russia are are only just emerging from recession. This lack of synchronicity in the global economy will prevent a surge in growth or major upward pressure on commodity prices. However, because the pace of growth is gradual, the global economy is able to expand without stoking inflation and thus drawing a major policy response from central banks. A decade on from the financial crisis, the global economy is finally in a sweet spot, albeit one that will prove shortlived. Among the consequences of the strengthening economic outlook are rising bond yields. Bond yields in the US and other developed markets bottomed out in mid 2016 and were given a shot in the arm by the election of Donald Trump at the end of the year. As businesses lost confidence in Mr Trump's ability to pass pro-growth policies, yields slipped in the first half of 2017. A speech in June by Mario Draghi, the president of the European Central Bank (ECB), in which he suggested that "deflationary forces" had been replaced by reflationary ones, jolted financial markets and pushed up bond yields by as much as 25 basis points in some euro zone economies. Alongside this, the Bank of Canada raised its policy interest rate for the first time since 2010 in June, and the Bank of England (BoE, the central bank) has struck a more hawkish tone. However, we do not believe that a concerted move towards higher interest rates among developed economies is imminent. The BoE is unlikely to raise rates until 2021. The ECB may wait even longer, after beginning to taper its quantitative easing programme in 2018. Monetary tightening in Canada will be gradual. The Fed is proceeding gradually in comparison with previous cycles. All of these economies still have slack in their labour markets and are experiencing either slowing consumer price inflation or high levels of imported inflation due to currency weakness. These forecasts suggest a manageable debt burden for those in OECD markets and a benign environment for emerging-market borrowers with hard-currency debts to refinance. Against the backdrop of a steadying global economy lies the highest level of political risk in years. At the centre of this is Mr Trump's administration in the US. Mr Trump is an unpredictable, thin-skinned and impulsive leader. This makes him a difficult ally for both Republicans at home and the country's allies abroad. It is also leading to a chaotic foreign policy, which, given the US's international reach, has consequences all round the globe. The US is seeking to abdicate its leadership of global geopolitics, as demonstrated by its withdrawal from the Paris climate agreement, its departure from the Trans-Pacific Partnership free-trade deal and Mr Trump's refusal to guarantee US support for NATO's Article 5. This is causing allies such as Germany and Canada to strengthen alliances elsewhere and offering

Germany 38 the US's rivals, including Russia and China, the chance to broaden their influence. US consent is also likely to have enabled the Saudi-led boycott of Qatar that began in June. We believe that the shift in US foreign policy poses enormous downside risk to political stability and growth in the global economy. Were the US to withdraw from the North American Free-Trade Agreement (NAFTA), trade tensions with China to escalate into boycotts and embargoes or worse, or the US and North Korea to stumble into conflict under the impression that military action from the other was inevitable, the consequences for the global economy would be broad and severe. Developed world The US economy is in relatively good shape, buoyed by rapid employment growth and rising house prices. However, wage growth has failed to take off despite the unemployment rate falling to its lowest level since 2001. We attribute this to a lower natural rate of unemployment, which means we have pushed back the date when we expect a business-cycle downturn by a year, to early 2020. In the period until then, GDP will grow by 2.2% a year, which represents the post-crisis new normal for the US. Europe's ongoing recovery phase will be consolidated over the forecast period, although political risk will remain high. For Japan we forecast growth averaging just 1% a year in 2017 21. The economy will be constricted by a shrinking workforce, a rising old-age dependency ratio and tight immigration controls. Inflation will remain well short of the Bank of Japan's target of 2%. Emerging markets The outlook for emerging markets in 2017 18 is reasonable, with growth quickening to 4.2% from an estimated 3.8% in 2016. Brazil and Russia, the third- and fourthlargest emerging economies, will both emerge from lengthy recessions, and many will benefit from a double-digit rise in industrial commodity prices. Furthermore, we expect financing conditions to remain relatively benign, albeit subject to occasional episodes of volatility. In 2017 China is on track to grow by 6.8%, which would be the first acceleration in growth since 2010. However, this growth is continuing to be generated partly through an increase in indebtedness, accompanied by rapidly rising property prices in some cities. We believe that this accumulation of debt, particularly in the corporate sector, is unsustainable, and we think that once the president, Xi Jinping, has consolidated his power at a party conference late in the year, he will sanction policies to rein in credit. Firms in the construction and real-estate sectors will be hardest hit. As a result, we forecast that growth will slow significantly in 2018, to 4.8%, from 6.8% in 2017. With China losing momentum, India will be Asia's fastest-growing large economy in 2017 21, expanding at an average annual rate of 7.6%. However, the economy is also going through a painful period. A lending spree earlier this decade has saddled state-owned banks with bad loans. Combined with excess capacity in the steel industry, this will depress corporate lending and investment for some time yet. We expect GDP growth in fiscal years 2016/17-2017/18 (April-March) to average 7.4%, before growth accelerates as the major reform programme led by the pro-business prime minister, Narendra Modi, generates greater benefits, especially in infrastructure and policymaking. Brazil's emergence from a two-year recession will help to lift aggregate growth in Latin America back into positive territory in 2017. But Brazilian growth will be meagre on a year-on-year basis as the country's damaging and protracted corruption scandal dampens confidence. We have revised up Mexican growth again, to 2.3%; the economy has been resilient in the face of deep uncertainty surrounding US- Mexican relations under the Trump presidency. The risk of weakening relations between the US and the wider region is high. The tenor of US trade and migration policies will be crucial. Our forecasts assume that Mr Trump's actions will largely fail to match his startling rhetoric.

Germany 39 Prospects for rapid economic growth in the Middle East and North Africa (MENA) remain stifled by social unrest, war and terrorism. We expect the Saudi-led boycott of Qatar to last for years, as neither side will be willing to back down. As the situation evolves, the conflict will enter a new phase of tighter economic sanctions on the tiny Gulf state, which will undermine the position of the Qatari emir, Sheikh Tamim bin Hamad al-thani, and see the economy slide into recession. Elsewhere, we expect a general improvement in the region's economic outlook in 2018 21. Iran will drive this, owing to growth of over 5% a year. Coupled with the positive impact of a broad commitment to improving business environments, this will enable faster growth. However, our assumption is that oil prices will not be sufficient to enable exporters to restore the expansionary fiscal policies that were in place in 2011 14. Following a dismal performance by Sub-Saharan Africa in 2016, when growth was the slowest in 25 years, economies will perform better in 2017 18. Prices for exported commodities will rise, and the weather is likely to be more clement. Exchange rates After several years of historic highs, the US dollar has steadily lost value during 2017. We expect this trend to be partially unwound over 2018 19. Financial markets are overly sceptical about prospects for further Fed tightening. We now expect another 200 basis points of rate increases by early 2020. As financial markets reappraise the interest-rate outlook, the US dollar will once again begin to look more attractive. Nonetheless, we do not expect the dollar to recover to levels seen in late 2016. From 2020 the dollar is likely to resume a weakening trend as the business cycle turns and the Fed begins to cut interest rates. Commodities The OPEC production cut agreement has failed to deliver the desired rise in oil prices. We expect the cartel to be forced to extend the deal until the second half of 2018 and to unwind it only gradually, to avoid a disruptive market crash. We expect the price of dated Brent Blend, the international benchmark, to rise to an average of US$52/barrel in 2017 as the market registers a small deficit, before inching back down to US$50.8/b in 2018 as the OPEC deal slowly unwinds and as demand growth slows in the second half of the year, particularly from China. World economy: Forecast summary Real GDP growth (%) World (PPP* exchange rates) World (market exchange rates) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 3.4 3.4 3.6 3.4 3.2 3.6 3.3 3.5 3.2 3.7 2.3 2.4 2.7 2.7 2.3 2.8 2.6 2.6 2.2 2.7 US 2.2 1.7 2.6 2.9 1.5 2.1 2.1 2.2 0.8 1.9 Euro area -0.8-0.2 1.3 2.0 1.8 2.0 1.8 1.7 1.5 1.6 Europe 0.2 0.8 1.8 1.9 1.8 2.1 1.9 1.8 1.7 1.9 China 7.9 7.8 7.3 6.9 6.7 6.8 4.8 4.9 5.4 5.1 Asia and Australasia 4.4 4.6 4.1 4.2 4.1 4.4 3.6 3.7 3.6 4.1 Latin America 3.0 2.8 1.3 0.2-0.8 1.3 2.2 2.4 2.2 2.9 Middle East & Africa Sub-Saharan Africa World inflation (%; av) World trade growth (%) 3.9 2.2 2.6 2.4 4.0 2.3 3.3 3.5 3.3 3.9 4.2 4.7 4.5 3.0 1.1 2.2 3.0 3.2 2.7 3.6 4.0 3.8 3.6 3.2 3.8 4.3 3.9 3.6 3.0 3.0 3.5 4.0 4.5 3.1 2.5 4.0 3.2 3.1 2.4 3.7

Germany 40 Commodities Oil (US$/barrel; Brent) Industrial raw materials (US$; % change) Food, feedstuffs & beverages (US$; % change) Exchange rates (av) 112.0 108.9 98.9 52.4 44.0 52.1 50.8 53.1 52.9 55.5-19.4-6.8-5.1-15.2-2.2 16.5-0.8-0.3-3.8 2.7-3.5-7.4-5.2-18.7-3.5-0.5 1.2 4.0-1.6 2.4 :US$ 79.81 97.56 105.86 121.02 108.76 111.14 109.22 110.10 103.48 100.00 US$: 1.29 1.33 1.33 1.11 1.11 1.13 1.16 1.15 1.20 1.20 *PPP=purchasing power parity Source: The Economist Intelligence Unit. September 6, 2017 Full-year growth set for best performance since 2011 The Federal Statistical Office (Destatis) confirmed on August 25th that the German economy expanded by 0.6% quarter on quarter in April-June (seasonally and working-day adjusted), easing slightly from an upwardly revised 0.7% in January-March, but still a very healthy rate of growth in the post-crisis context. Combined with high-frequency data released for the third quarter, this indicates that growth will exceed 2% this year, only the seventh time that this has happened since 1991. At present the outlook is highly positive, and the stable political backdrop provides another reason for optimism. However, the spillover effects from Brexit, a potential rise in protectionism in the US, ongoing populism in the EU, an expected slowdown in China, and the domestic "dieselgate" and cartel scandals could throw growth off track next year. In quarterly terms, growth in the second quarter was primarily driven by private consumption, which added 0.5 percentage points to the headline rate. Government spending added 0.1 percentage point, and gross fixed capital formation and change in stocks contributed an additional 0.2 percentage points each. Net exports subtracted 0.4 percentage points from the headline rate. In year-on-year terms, the rate of (unadjusted) real GDP growth slowed markedly to 0.8% in the second quarter, from 3.2% in the first quarter. However, this largely reflects distortions caused by differences in the number of working days. When adjusted for working days, real GDP growth was 2.1% year on year in April-June, slightly higher than the 2% posted in January-March on this measure. Growth on an annual basis was also driven by domestic demand, with private consumption, government spending and investment all making positive contributions. Net exports contributed negatively, as imports rose by 5.4% year on year, far outpacing the 3.5% increase in exports. By comparison, in real seasonally and working-day adjusted terms, GDP in the second quarter of 2017 was 10% higher than in the first quarter of 2008. The most significant increases over this period were for imports (32%), exports (27%) and government spending (20%). Private consumption was up by 11% and investment by 10%.

Germany 41 Hourly productivity up, but Germans working fewer hours That private consumption was a major driver of growth in the second quarter is in line with trends in place since mid 2014, reflecting the strength of the labour market and earnings growth. Total employment reached 44.2m in April-June, according to Destatis, up by 1.5% year on year. Moreover, those in work are also producing more efficiently: Destatis reported that, adjusted for the number of hours worked, output per person in employment rose by 1.2% year on year in this period (based on provisional calculations). However, Germans are working fewer hours on average, and so overall labour productivity (output per employed person) fell by 0.7% year on year. There are several possible reasons for this, although involuntary underemployment (where people would like to work more hours but are unable to do so) may be one reason. Much of the recent job growth in Germany has been in the services sector, where temporary and part-time contracts are widespread. Outlook remains positive There is no immediate reason to think that the current robust growth momentum will be thrown off track soon. Demand from important export markets looks to remain strong. Nominal euro-denominated merchandise exports rose in year-on-year terms in the second quarter in four of Germany's five most important export destinations: China (7.8%), France (4.9%), the Netherlands (7.1%) and the US (0.6%). The contraction in exports to the UK ( 3.8%) in this period reflects the impact of Brexit risks on the UK economy and the weaker pound, which are unlikely on their own to derail the German export industry. The strength of the euro is regularly highlighted as a risk for German exporters, but there is little evidence that this has been an issue in the past for Germany; its exporters tend to compete more on quality than price.

Germany 42 On the household side, the labour market is continuing to perform well. Employment growth has been running at 1.5% year on year since January, according to the monthly series by the Bundesbank (the central bank), the fastest rate on this measure since January 2012. Wage restraint remains prevalent, although earnings growth is starting to be more visible. According to Eurostat, wages in industry (excluding construction) rose by an average of 3.3% year on year in the first half of 2017, up from 2.5% in 2016. The Bundesbank series for the whole economy showed weaker growth of 2.3% over the same period, slightly up from 2.1% last year (although lower in real terms given the pick-up in inflation). Sentiment indicators remain upbeat. The composite purchasing managers' index (PMI), which tends to be a reliable predictor of short-term growth trends, reached 55.8 in August (anything above 50 indicates expansion), up from 54.7 in the previous month, albeit slightly down from 56.8 on average in the second quarter. The manufacturing index rebounded to 59.3, from 58.1 in July, and services rose to 53.5, from 53.1. Respondents noted that employment and new orders were strong in August, with the latter said to be driven in particular by higher demand from Asia. The Institute for Economic Research (Ifo) business climate index slipped slightly in August, but remains close to a record high. Crucially, the sub-index for expectations reached its highest level since January 2014. Part of the optimism may be related to the political situation, with populist parties struggling to gain a serious foothold in German politics, and the chancellor, Angela Merkel, set to remain in position after the September parliamentary election. As a result of these various factors, we are likely to make an upward revision to our 2017 growth forecast during our next forecasting round. Where are the risks? The near-term outlook for the German economy is as rosy as it has been for some time. However, there are clearly risks, both at home and abroad. Domestically, the emissions scandal currently hanging over Germany's carmakers could derail growth. Cars are Germany's single biggest export, and account for around 800,000 jobs. The Ministry of Finance's monthly report, released on August 21st, highlighted this as a risk to the economic outlook. Earlier in August carmakers met and agreed to change the software in 5.3m diesel cars. Germany's car industry could also face big fines if an EU antitrust probe finds evidence of cartel practices. The Centre for European Economic Research (ZEW) economic sentiment index dipped to 10 in August, from 17.5 in July and below market expectations of 15, amid reports that the emissions and alleged cartel scandals were weighing on sentiment. Externally, the risks may be even more significant, particularly given Germany's fairly strong reliance on high-value exports. The protectionist rhetoric from the US president, Donald Trump, and the UK's Brexit course look likely to bring most