The Bundesbank said geopolitical tensions may impede a rebound of the German economy, Europe's largest, after it contracted in the second quarter.
"The economic outlook for the German economy has clouded over in the middle of the year in response to unfavorable international news," the Frankfurt-based central bank said in its monthly report published today. "Expectations for a strengthening of economic momentum in the second half of 2014 underlying the spring projections are called into question by current data."
Today's report is the strongest warning yet from the Bundesbank, which said in the past that economic weakness in the second quarter will be temporary, and it signals that forecasts published only two months ago may be too optimistic. Pared with a lack of growth in France and Italy in the period, German prospects threaten to weigh on a euro-area recovery that the European Central Bank (ECB) is trying to sustain with unprecedented stimulus.
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"There are signs that the euro area will resume its economic recovery after the stagnation in the second quarter, even though it probably won't reach the pace projected in spring," the Bundesbank said in its report. "The economic momentum in some member countries of the European monetary union is weaker than expected. At the same time, it seems geopolitical tensions in Eastern Europe as a result of the Ukraine conflict, as well as in other parts of the world, now weigh more on business confidence."
The Bundesbank predicted in June that the German economy will expand 1.9 percent this year and 2 percent in 2015. That compares with ECB forecast of euro-area growth of 1 percent and 1.7 percent, respectively. The ECB will published updated projections for the currency bloc in September, while new Bundesbank estimates for Germany are due in December.
After the EU curbed Russia's access to bank financing and advanced technology last month and the country responded by banning some agricultural imports from the region, ECB President Mario Draghi warned that "heightened" geopolitical risks may affect economic conditions negatively.
"Toughened sanctions against Russia and retaliations of the government there won't be without impact" on German exports, the Bundesbank wrote in its report. "At the same time, confidence is weakening from a high level, which, together with overall positive domestic demand, speaks against a turn in economic fundamentals."
The German economy contracted 0.2 percent in the second quarter after expansing 0.7 percent in the three months through March. The Ifo Institute's business climate index for Germany dropped for a third month in July after rising to the highest since 2011 earlier this year.
To support the euro region's recovery and fuel inflation running at less than a quarter of the ECB's mandate, policy makers unveiled a package of measures in June that included a negative deposit rate and targeted cash injections for banks. Draghi also held out the prospect of purchases of asset-backed securities and quantitative easing.
"Since medium-term inflation expectations currently undercut noticeably the rate the Eurosystem strives for, the agreed package of measures is overall acceptable," according to the Bundesbank's report. "At the same time, expansionary monetary policy comes with the danger that there will be market excesses and that consolidation and reform efforts of member states in the monetary union wane."
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