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Germany no longer set to drive growth in Europe: Morgan Stanley

A worker checks the frame of a BMW automobile along the production line at the BMW plant in Munich, Germany.
Martin Leissl | Bloomberg | Getty Images

The powerhouse German economy will no longer outperform the euro zone in 2017 according to a new report from Morgan Stanley.

Germany is the largest economy in Europe with a nominal gross domestic product (GDP) in 2016 of $3.5 trillion, according to the International Monetary Fund (IMF).

The country, a founding member of the European Union, is often lauded for its skilled manufacturing base and strong export surplus.

However a new note Tuesday from Morgan Stanley's chief European economist, Elga Bartsch, suggests the German engine may be spluttering.

Citing external headwinds, the note forecasts German GDP growth will slow from 1.5 percent this year to just 1 percent next year, no longer outperforming the wider euro zone.

Morgan Stanley data said the last time that occurred was 2009.

Morgan Stanley

"A likely shortfall in foreign demand and the profound uncertainty on the future of the EU (European Union) created by the UK vote to leave will likely hit the trade-oriented, cyclical German economy harder than others," the note reads.

Morgan Stanley's GDP indicator tips third quarter growth in Germany to reach just 0.1 percent, highlighting that companies scaled back output plans and recorded a sharp fall in new orders in August.

The note suggested domestic demand will be the main source of growth across the remainder of 2016.

"For now, the refugee-related spending and a 5 percent increase in pension benefits on July 1 add to the domestic demand momentum.

"However, next year rising headline inflation, higher welfare taxes, lower immigration flows and rising unemployment rates will likely limit the momentum."

Bartsch's report also highlights that the German election in the second half of next year will take place amid the economic slowdown.

"Ahead of the 2017 general election, we will likely see an increase in the political frictions between the coalition partners, CDU/CSU and SPD, on key issues including fiscal discipline and European integration.

"The latter will likely make it increasingly difficult to negotiate the UK's exit from the EU and international trade agreements or to agree to any additional bail-outs," the note predicted.