Where did the German ‘strongman’ go?

This week's disappointing German manufacturing data are the latest sign the "strongman" of Europe is weakening, in what could mark a worrying turn for the rest of Europe.

Tuesday's industrial output numbers for Germany missed forecasts, with production slowing by 4 percent month-on-month in August. German factory orders, out on Monday, also showed a steep—and unexpected—decline.

"The data from Germany is persistently dreadful," said Societe Generale's Kit Juckes in a note on Wednesday.

Brandenburg Gate
Pascal Boegli | Getty Images

The warning comes after the International Monetary Fund (IMF) cut Germany's growth outlook for this year and next on Tuesday. It now sees the economy growing by 1.4 percent in 2014 and 1.5 percent in 2015. This is better than the euro zone average, but below peers like the U.K., where the economy is expected to expand by 3.2 percent this year and 2.7 percent next.

Here we take a look at some of the reasons why Germany could be losing its economic clout:

Austerity

France has criticized Germany for hoarding cash rather than using it to stimulate domestic demand, which could help boost growth throughout the euro zone.

"Germany must fulfil its responsibilities," French Prime Minister Manuel Valls declared at a policy meeting last month.

Now, some economists say the zealous fiscal prudence exercised by Chancellor Angela Merkel and colleagues is harming Germany, as well as its neighbors.

"The figures should provide something of a wake-up call to those in the German government still resisting calls to loosen the fiscal reins and provide the euro zone's biggest economy with more support," said Jonathan Loynes, chief European economist at Capital Economics, in a note on Wednesday.

Bank analysts and the IMF have called for Germany to increase public investment via large-scale infrastructure projects.

"Both public and private investments have remained sluggish in the current recovery," said Carsten Brzeski, chief economist at ING, in a note on Wednesday. "At the same time, however, several investment-intensive sectors offer an enormous potential to improve Germany's long-term growth. Just think of infrastructure (rail, road but also internet) and the transition towards renewable energies and education."


Weak growth in peers

Germany is also suffering from ongoing weak demand in many of its euro zone neighbors. The region's gross domestic product (GDP) came in flat—below expectations—in the second quarter, and its real GDP is still around 2.5 percent below its pre-crisis peak—and 5 percent below if Germany is excluded, according to BNP Paribas.

The country's very open economy makes it highly vulnerable to low demand in other countries. Exports account for around half of German GDP, and while trade with China and other emerging markets is rising, Germany's major partners remain European—notably, France, the U.K., Austria and Italy.

"The external trade sector will contribute very little to growth over the next few quarters," warned Evelyn Hermann of BNP Paribas in the bank's September "Global outlook" report.

Meanwhile, ING's Brzeski noted: "Downside risks for the German economy currently do not mainly come from geopolitical tensions but rather from longer-than-expected weak demand from euro zone peers."

Ukraine-Russia crisis

Euro zone exports to Russia have fallen since early 2013 in euro terms, driven partly by the Russian Federation's economic straits, but mostly by the ruble exchange rate.

Trade has fallen further this year, following Russia's incursion into Ukraine and the tit-for-tat sanctions by the West and Moscow that have followed. Russia has restricted food imports, while Europe and the U.S. have cut Russian state-owned companies' access to finance and frozen some leading politicians' assets.

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In the first six months of this year, German exports to Russia fell 13 percent on the same period in 2013. This is problematic because Germany has strong economic ties with Russia—2 percent of its GDP is directly exposed to the country, according to BNP Paribas.

The crisis has also hit Germany's trade with eastern Europe, which buys around 10 percent of German exports, and business with other nearby emerging markets, like Turkey.

Business confidence in Germany has also taken a knock. The widely watched Ifo Business Climate Index fell for a fifth consecutive month in September to its lowest level in nearly 1-1/2 years.

"Increased (geopolitical) tensions could derail German growth more than we expect," warned BNP Paribas's Hermann.