Germany: This Slump Could Be Infectious

Just how bad is Germany's slowdown? Although signs of weakening have been multiplying since spring, the latest data suggest the euro zone's largest economy could hamper recovery in the entire region.

Germany's manufacturing sector is getting hit by softer domestic demand and exports. In September, the purchasing managers' index slipped to 48.9%, and, while industrial output rose 1.8%, the Finance Ministry said the number may be revised lower.

The future looks equally grim. Although factory orders rose 1.7% in August, it was the first gain in three months. And the IFO Institute reports executives are growing more pessimistic. Little wonder, then, that the European Commission's indexes of industrial confidence show German businesses are the most downbeat of all in the euro zone.

Surprisingly, German consumers are slightly more confident about their economy than other euro zone residents. But they still remain wary about their individual fortunes. That may reflect the weakness in the labor markets. The number of unemployed fell by a slim 1,000 in September, and the jobless rate remained at a high 9.8%.

Growth in Germany's real gross domestic product is likely to slow sharply in the second half from the 1.1% annual rate in the first two quarters, in part because of activity lost during the summer floods. And the government has cut its forecast for 2003 growth to 1.5%, from 2.5%. Since Germany is a prime market for other euro zone products and attracts foreign capital, its slowdown will curtail trade and investment flows for the entire region well into 2003.

Prime Minister Gerhard Schroder, reelected in late September, is responding to the slump by reshuffling his cabinet and moving ahead with labor reforms. Germany's weakness is also raising expectations among investors that the European Central Bank will cut rates again before the end of the year. These moves will help 2003 growth, but they will come too late to reverse this year's slide.

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