FT.com / World / Europe - German economy to continue growing

FT.com / World / Europe - German economy to continue growing

German economy to continue growing
By Ralph Atkins in Frankfurt

Published: March 20 2007 17:27 | Last updated: March 20 2007 17:27

The chrome and red-panelled coffee bar at BMW’s main showroom in Frankfurt, Germany’s financial capital, is busy with lunchtime customers There is scant evidence that this is an industry hit by the biggest tax increase in the country’s history.

A three percentage point rise in German value added tax at the start of 2007 has had “as good as no effect”, says gently smiling Philipp von Sahr, a 20-year BMW veteran who heads the local sales team.

Mr von Sahr’s upbeat assessment illustrates one of the biggest surprises of recent economic history. When Angela Merkel, chancellor, unveiled plans to shore up the country’s finances with the tax increase, economists predicted a large jump in inflation and said Germany’s economic recovery would go into reverse.

Three months after the rise, inflation is up and activity has probably slowed temporarily. But growth forecasts for 2007 are being revised up as other, overwhelmingly positive, factors compensate for any damaging impact of the VAT rise.

At the spacious, brightly lit BMW showroom on Frankfurt’s Hanauer Landstrasse, sales of new cars have held up largely because it serves a disproportionately high number of business clients, who can reclaim the VAT. But Mr von Sahr also pays tribute to BMW’s products and to German economic confidence.

“Department stores probably saw a rush of sales in October, November and December and then a slack period in January. For us the boom and then slack period have been much less. We’ve had a good start to the year, we’re pleased.”

Nationally, car dealers have not been as lucky – new car registrations in February were 15 per cent lower than the same month a year before, according to the VDA automotive industry association. German retail sales excluding cars have also fallen, by 5.1 per cent in January compared with December.

But the evidence suggests that simply the timing of purchases changed; car sales soared late last year, before the VAT increase. At the same time the German recovery appears to have been sufficiently strong at the time of the VAT rise to withstand the shock: global demand has supported growth, industrial production is up and business confidence – as shown by indicators such as the Ifo institute’s business climate index – remain high.

“It is hard to say that the VAT increase has scared people, or made companies less likely to hire or invest,” says Dirk Schumacher, economist at Goldman Sachs.

Whereas negative growth had been expected in the first three months of 2007, economists now believe figures released on May 15 could show that German gross domestic product in the first quarter will have increased by as much as 0.5 per cent (after an exceptionally strong 0.9 per cent in the fourth quarter of 2006).

The effects on inflation have also been more benign than originally expected. The Kiel-based Institute for the World Economy (IfW) estimates that, by January, the VAT rise had increased German inflation by up to 1 percentage point, with a large part of the rise having occurred as early as last October. In turn, inflation in the 13-country eurozone was probably about 0.3 percentage points higher than it would otherwise have been.

But the effects have been wiped out by falling oil prices. Despite all the gloomy prognosis to the contrary, eurozone inflation, at just 1.8 per cent in February, remains clearly within the European Central Bank’s target of an annual rate “below but close” to 2 per cent.

The chances of a VAT-caused inflation shock have passed, says Carsten-Patrick Meier, one of the authors of the IfW report. “In principle, the whole effect must have gone through.”

That will not stop the ECB worrying: its monthly bulletin last week noted that “some further effects may still occur”. But the central bank’s inflation angst is being driven more by fears that prices will rise as a result of stronger growth squeezes at capacity limits and encourage higher wage settlements.

Does Germany’s VAT experience offer lessons for other European countries with large budget holes? The European Commission, keen to encourage fiscal discipline, supported Berlin’s move. But Germany’s VAT rate was lower than that for many other eurozone countries.

At the Frankfurt BMW showroom, Mr von Sahr would not wish a VAT rise on others. “It wasn’t a measure that boosted the economy, let’s put it that way.”

Copyright The Financial Times Limited 2007