German Economy Shrinks Unexpectedly, Adding to Europe’s Risk

Posted November 14, 2018 4:25 p.m. EST

BRUSSELS — Germany’s once unstoppable economy has gone into reverse, adding another threat to European stability just as Italy escalated its dispute with fiscal overseers in Brussels.

The European Union’s bedrock economy unexpectedly shrank 0.2 percent in July through September compared with the previous quarter, according to data published Wednesday by Germany’s official statistics agency. It was the first quarterly contraction since 2015, with a drop in exports suggesting the stall was a manifestation of President Donald Trump’s trade war with China.

If the quarterly decline in Germany signaled a trend — which some economists doubted — the implications for the rest of Europe would be ominous at a time when Italy is rattling financial markets. Italy’s populist government, which faced a deadline Tuesday to resubmit a national budget earlier rejected by the European Commission, made only minor concessions. The commission, the EU’s executive arm, is expected to respond next week.

As Europe faces a confluence of economic and political turbulence, Germany and its powerful auto and machinery exporters have provided crucial stability.

Without Germany as a locomotive, Europe would have much more trouble withstanding shocks that, in addition to Italy, include Britain’s messy separation from the EU and trade tensions with the United States.

Economists expressed hope that Germany could bounce back quickly from the surprise decline in output, which was caused in part by temporary production backlogs at automakers. All the major carmakers have struggled to adjust to new, more rigorous European emissions testing procedures.

Germany’s Federal Statistical Office blamed the setback on reduced exports. China is an important customer for Mercedes-Benzes, Volkswagens and BMWs as well as German-made factory machinery. But China has been buying fewer German goods because its economy has suffered from tariffs imposed by the United States.

“I don’t think this is the start of a trend,” said Carsten Brzeski, chief economist at ING Bank in Germany. “But assuming it is, it clearly means bad news for the rest of the eurozone.”

Italy’s continued confrontation with the European Commission could have economic consequences for the eurozone if not the entire world. The country is seen as a threat to financial stability because of its enormous government debt, which equals more than 130 percent of gross domestic product.

The Italian government, a coalition between the anti-establishment Five Star Movement and right wing Lega, is trying to finance welfare programs as a solution to economic stagnation. But its spending would produce a deficit considered dangerously high for a country with so much debt.

In letters to the European Commission late Tuesday, Giovanni Tria, the Italian finance minister, promised to speed up the sale of state assets to help reduce government debt. Otherwise, he made only minor changes to a budget that the commission had rejected.

The spending is limited to what “is strictly necessary to counteract the slowing of the economic cycle,” Tria wrote. And he said some of the outlays were justified by emergencies, including flood damage and investment in roads and other infrastructure after a deadly bridge collapse in Genoa.

The European Commission will issue an opinion by next Wednesday, a spokesman said. What happens after that is uncertain.

Officials in Brussels will try to walk a fine line, enforcing EU rules while avoiding a war of words with Rome that would play into the hands of populists. The commission could penalize Italy by imposing fines or withholding EU funds for economic development. But the commission rarely moves quickly.

The big risk is that investors will lose confidence in Italy and no longer buy government bonds at interest rates the government can afford, a development that would ripple through the economy. The risk premium on Italian bonds spiked early Wednesday, though it later retreated.

The International Monetary Fund said the stimulus would be futile unless paired with measures to improve the functioning of the economy such as dismantling rules that make it costly for businesses to fire workers.

Without such changes, the IMF said in a report on Monday, the spending plan could backfire.

“Italy could be forced into a large fiscal consolidation when the economy is weakening,” IMF economists wrote. “This could transform a slowdown into a recession.”