What is happening with Germany?

Long-time readers will know that I have held an upbeat view with respect to Germany for a long time due to a number of reasons. One of the reasons has been the easy monetary environment provided by record low real yields (ongoing) as well as by the weak exchange rate. More important for Germany than the level of the trade-weighted Euro is the level of the EURJPY cross rate even though Germany does not have strong direct trade relationships with Japan. However, Germany and Japan are key competitors in the global markets for items such as cars, machines or chemicals. The collapse of EURJPY since the outburst of the financial crisis in 2008 has helped German exporters gain market share, especially in Asian markets, at the expense of their Japanese counterparts. Following the radical easing in monetary policy by the BoJ, EURJPY has shot upwards by approx. 30% within a matter of a few months.

EURJPY and EUR trade-weighted index

Source: Bloomberg 

This has important implications, not only for the German economy but also for the Eurozone overall:
a) The sharp rise in EURJPY constitutes a net tightening the monetary environment for Germany. German exporters are likely to face a more challenging export environment, especially in Asian markets. This will render the current economic upswing softer than would be the case otherwise.
b) The sharp rise in EURJPY does not have significant tightening effects on the other Eurozone economies, most notably France and the periphery. These economies compete to a much lower extent with Japanese exporters in world markets and hence a higher EURJPY is no issue. Rather, the likely flow of capital out of Japan (as the BoJ reduces the amount of JGBs available for private investors and hence cash needs to be invested elsewhere, likely also in Eurozone bond markets) helps to depress the yields of semi-core and peripheral sovereign bonds. Hence, the monetary environment in the periphery/semi-core gets more accommodative.
c) A weaker-than-expected state of the German economy increases the chances of further easing steps by the ECB (repo rate cut, moving into the direction of forward guidance, unconventional steps to promote the flow of credit to SMEs), supporting growth in the periphery via lower yields and a lower Euro (on a trade-weighted basis).

Overall, the German economy should see a growth recovery but a slower one than would have been the case otherwise whereas the support provided by the monetary environment for the periphery has been increasing and will increase further. As a result, growth differences between various Eurozone countries should become less pronounced.