News & analysis

The German economy shrank by 10.1% in Q2 on a quarterly basis, one percentage point deeper than the consensus forecast supplied to Bloomberg. The slump depicted the damage inflicted by lockdown measures imposed for most of the second quarter, even though Germany has been praised for its overall response to the pandemic and early scaling back of containment measures.

The Government Response Stringency Index built by the Oxford Covid-19 Government Response Tracker (OxCGRT) was nearly 73/100 average scale between March and June.

By this measure, lockdown policies in Germany were more restrictive than the UK’s, US’s and Japan’s throughout that period but fairly looser than any other major euro-area economies, suggesting tomorrow’s release of France’s and the eurozone wide Q2 flash GDP reading may also bring negative surprises.

Consecutive declines in private consumption and investment along with drops in exports aggregated to record the deepest slump in the German economy since the series was first registered in 1970. On the bright side, automatic stabilizers such as the job retention scheme helped ease the damage: the state-funded German safety net known as Kurzarbeit covered 60-67% of lost net wages and was also expanded to contract workers and social insurance contributions. Another support measure for the economy was the strong fiscal stimulus, providing trillions of euros to struggling businesses and households with loan guarantees, equity injections, and additional liquidity. Breakdown data on the ECB PEPP purchases showed that Germany was benefited from an excess supply of funds relative to the country’s capital key in ECB’s portfolio, suggesting the swift monetary support to the largest EU economy also helped cushion the blow. It is worth noting that the support measures will likely have a lag time to filter through to the economy. For example, the Kurzarbeit scheme will have done little to protect consumption levels from the pandemic’s effects in Q2 but will aid with the recovery as lockdown measures are scaled back. However, a bigger-than-expected economic collapse is just a first sign of the challenges ahead. With coronavirus cases reappearing in Europe, leading to the potential re-imposition of local lockdowns and international restrictions, the prospects of a sharp economic recovery are in question.

The euro has felt the hit, reversing part of its sustained rally over the last six weeks where the single currency hit its highest level against the dollar since 2018.

The surge in the common currency had been built mainly on the back of broad dollar weakness and future growth differentials with the US, while the unambiguous support by the ECB and the agreement on the EU common recovery package has added to the market’s confidence of a stronger economic recovery in the EU. The euro could potentially continue this path in the following months as the appetite for the dollar fades on the back of a plummeting US economy and continued fiscal and monetary stimulus in North America. However, a couple of warning signals are shown in today’s price action following the German GDP figure – which was still one of the milder economic contractions in the eurozone.

A worse-than-expected economic collapse in the area may make clear that the single currency is relatively overbought compared to its current economic fundamentals and previous history, tilting the balance of risks to the currency forecast to the downside.

This is more likely the case under the light of recent coronavirus outbreaks in Europe, bringing back fears of stringent measures to be put in place again. On the other hand, global risks to the economic rebound priced in by markets might return the faded privilege to the USD dollar if the Covid panorama worsens worldwide, with ample room for correction after the greenback sits at two-year lows as measured by the DXY index.


German GDP underperformance on looser lockdown restrictions sets the tone for Eurozone incoming data.


EURUSD halts its largest rally in two years after the worst-than-expected German GDP collapse in Q2.



Author: Olivia Alvarez Mendez, FX Market Analyst



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