By Balazs Koranyi
FRANKFURT (Reuters) - It was meant to be a fleeting slowdown for Europe's economic powerhouse, followed by a rapid rebound.
Instead, Germany has been stuck in neutral for a year with hopes fading for a turnaround, a situation that threatens to spread lasting economic gloom across Europe.
Its vast industry is in recession, a victim of shifting consumer trends, China's economic rebalancing, and a global trade war. Investment spending is shrinking, sentiment is souring, job creation has stalled and productivity growth looks to have turned negative.
Compounding the pain, what was thought to be an unfortunate coincidence of one-off factors has turned out to denote deeper structural problems that will keep Germany, and by extension, the 19-member euro zone, weak well into the next decade.
Exhibit A will be Thursday's release of third-quarter growth data, which is expected to confirm fears that Germany is in recession. Whether the actual figure is minus 0.1%, as a Reuters poll indicates, or merely shows a flat outcome, does not change the bigger picture.
"Germany is likely to remain in a zone between modest positive growth and slight GDP declines," Commerzbank (DE:CBKG) economist Jörg Krämer said. "Once the downturn is over, however, there is unlikely to be a strong economic recovery ... the German export industry will suffer for a long time to come."
STRUCTURAL FLAWS
Germany's independent Council of Economic Experts delivered a similarly grim message just days ago: the good old days are over and it's time to reform.
Germany is slow to adopt new technology, investment is weak and barriers to starting new businesses are too high, said the five-person Council, whose members include Isabel Schnabel, soon to be a member of the European Central Bank's Executive Board.
Its rapidly aging population helps keep productivity growth weak: because the labor market is shrinking and skilled workers are hard to come by, firms hoard labor even during downturns for fear they will struggle to hire during the rebound.
Banks are of little help to the economy either. They operate with the highest costs in the euro zone and their combined return on equity in the second quarter was zero.
This is a problem because banks restrict lending when the economy slows to save capital, exacerbating any recession. And with earnings already weak, they are unlikely to support the economy.
"Banks' low profitability poses risks to financial stability, because it hampers the build-up of equity and provides incentives to take excessive risks," the Council said.
Stimulus would appear timely given this environment but little more is likely to come.
The ECB has already done almost all it could to lower borrowing costs. Indeed, the Bundesbank estimates the German state saved 368 billion euros in borrowing costs in the 10 years to the start of this year.
The government could use those savings to boost spending as it has one of the lowest debt levels in Europe. But in a country obsessed with running a balanced budget, meaningful fiscal stimulus is politically unacceptable.
Berlin has long resisted calls for a big spending boost, arguing that an aging population requires savings and that firepower must be preserved for a real crisis.
A surge in infrastructure investment would be problematic, anyway, as the construction sector is running at capacity, so it would struggle to absorb the extra cash.
Such a grim outlook does not automatically translate into economic gloom for others, and data on Friday showing German exports posted their biggest rise in almost two years in September offers a glimmer of light. But Germany is the top trading partner for most EU countries with value chains reaching well beyond borders.
Indeed, when the European Commission slashed its 2020 growth forecasts for Germany earlier this week, it also cut its projections for most EU countries.
As the Commission put it, the bloc is at a crossroads: it could enter a recession, muddle through with a protracted period of low growth or find a way to rebound, seen now as the least likely outcome.
The eventual direction depends very much on Germany.
POWELL, TRUMP
Besides German GDP data, U.S. President Donald Trump's decision on car import tariffs will also be in focus.
Having already reached a deal with several major importers, the decision is essentially about whether to impose additional duties on cars from the EU, analysts say.
Any increase in car tariffs is likely to trigger immediate retaliation by Brussels, leading to a further escalation of a global trade war.
U.S. Federal Reserve Chair Jerome Powell is also likely to make headlines when he testifies to Congress on the U.S. economy on Wednesday.
Having cut rates for the third time this year just days ago, Powell is unlikely to deviate from his recent message, which suggested a pause in any further easing.
Powell said the Fed would stay put as long as incoming information about the economy was consistent with its outlook, a signal taken by markets to mean that the Fed, much like the ECB, would be on hold for some time to come.