German industrial output declined in March more than expected, stoking fears that a recession was imminent. Most of the decline in production was in the auto sector. Germany is Europe’s largest economy, and reducing manufacturing output could point to negative growth.
Nearly 19% of Germany’s economic output is manufacturing, which could lead to headwinds for European economic growth. Additionally, industrial orders fell by 10.7% in March, the most significant monthly decline since 2020 during the heart of the pandemic. With manufacturing output declining significantly in the auto space, there are several commodities that this contraction will impact.
Commodities used to build cars, like Aluminum and copper, could suffer. If people purchase fewer automobiles, they are likely to drive less, which could pressure gasoline and diesel. If there is less demand for petroleum products, crude oil will likely feel the pinch.
Additionally, manufacturing requires fuel, and natural gas is the most widely used fuel. If Germany slips into a recession, it does not bode well for the rest of Europe, which could further reduce the need for some essential commodities.
What is Industrial Production?
Industrial production is the total output of goods and services from an economy’s manufacturing, mining, and utilities sectors. It is typically measured by the production of the industrial sector of the economy, which includes manufacturing, mining, and utilities. Industrial production is an essential indicator of economic growth and is closely watched by economists and investors.
Industrial output is usually accompanied by capacity utilization. Capacity utilization measures the extent to which an organization uses its available resources, such as labor, raw materials, and machinery, to produce goods and services. It is calculated by dividing the actual output of a production process by the potential output.
Capacity utilization is an essential indicator of an organization’s efficiency and productivity. So, industrial production tells you how much was produced, and capacity utilization tells you how efficiently the production was attained.
Why is Industrial Production Important in Germany?
Industrial production is essential in Germany because it is a significant driver of economic growth. Nearly 20% of GDP is generated from Industrial Output. The German manufacturing figure compares to 12% of GDP in the United States. It is responsible for a large portion of the country’s GDP and provides jobs for millions of people. Industrial production also helps create a strong export market, which is essential for Germany’s economic stability. Additionally, industrial production helps to create a robust infrastructure, which is necessary for the country’s continued development.
The largest manufacturing sector in Germany is the automotive industry. It accounts for around 20% of the country’s manufacturing output and employs nearly 1 million people. Germany is the world’s third-largest producer of cars and the largest producer of commercial vehicles.
The other sectors that dominate German manufacturing include mechanical engineering, chemical manufacturing, and electrical industry.
According to the World Bank, exports accounted for approximately 46.2% of Germany’s GDP in 2019. German exports are worth $1.5 trillion. Germany exports various goods, including machinery, vehicles, chemicals, pharmaceuticals, electronics, foodstuffs, and textiles. These are all goods that are created during the industrial output process.
What Commodities Are Used in German Industrial Production?
Commodities used in German manufacturing include steel, Aluminum, copper, plastics, rubber, chemicals, and energy. Other commodities used in German manufacturing include wood, paper, textiles, and machinery.
Metals, plastics, and energy are critical components of the automobile manufacturing industry. These commodities could face headwinds if industrial output is contracted due to demand declines. Natural gas plays a dual role in this process. Natural gas is used as a source of energy to drive manufacturing and is also a product used to derive chemicals. Natural gas chemicals include ethylene, propylene, butadiene, benzene, toluene, xylene, methanol, ammonia, and urea. If chemical demand contracts, the demand for natural gas could also decline.
Additionally, aluminum manufacturing often uses natural gas as a fuel source. Natural gas is used to heat the Aluminum to the melting point and power the machinery used in the manufacturing process. Natural gas is one of the most volatile commodities. It is traded actively in CFD trading as well as on futures markets. Steel manufacturing often uses natural gas as a fuel source. Natural gas is used to heat furnaces and power other equipment used in steel manufacturing.
What Happens to Commodity Prices When German Manufacturing Declines
Theoretically, if the demand for manufactured goods declines, the price of the commodities used to make or facilitate manufacturing will also decrease. Unfortunately, the demand for a commodity is only one side of the equation. For prices to decline demand has to decline, and supply has to either remain the same, rise, or contract at a slower rate than the contraction of demand.
If commodity demand is declining in conjunction with falling industrial production, but the supply of specific commodities is falling faster, commodity prices could rise despite falling demand.
Various factors, including supply and demand, impact the price of commodities. Prices are also affected by production costs, weather, political and economic conditions, sentiment, and speculation. Supply and demand is the most critical factor, as it determines the equilibrium price of a commodity. Production costs, such as labor, energy, and transportation, also play a role in the price of commodities.
Political and economic conditions, such as trade policies, currency exchange rates, and inflation, can also affect the price of commodities. Finally, speculation can also impact the price of commodities, as investors may buy or sell commodities based on their expectations of future costs.
What Else Can Hamper Industrial Output
Currency movements can also have an impact on commodities. A strong euro makes German exports more expensive for buyers in other countries, making them less competitive in the global market. This situation can decrease demand for German exports, resulting in lower sales and profits for German companies. Additionally, a strong euro can make it more difficult for German companies to compete with companies from countries with weaker currencies.
A strong dollar, on the other hand, can also impact the value of commodities. Most commodities throughout the world are quoted in U.S. dollars. When the dollar goes up against the Euro, the value of the commodity increases in dollar terms, making it more expensive for companies that rely on commodities in Germany to purchase commodities. Currency movements, therefore, can create competing factors. While a stronger Euro makes Germany less competitive in exports on the global market, a higher dollar will increase the value of each commodity quoted in U.S. dollars.
How Does a Decline in German Manufacturing Impact Other Countries?
Germany is the fourth largest economy in the world. Therefore its exports and imports are significant with its largest trading partners. Germany’s largest trading partners are the United States, France, the United Kingdom, China, the Netherlands, Italy, Austria, Belgium, Poland, and Switzerland. Many of the countries that Germany trades with are in Europe; therefore, a weak German economy is likely to spill over into other European economies.
Germany is also a significant trading partner of the United States and China and buys manufactured goods from Germany. Weaker manufacturing in Germany probably means that exports are weak, and therefore the economies of its trading partners that import manufactured goods from Germany.
For example, China is the world’s largest buyer of cars, followed by the United States. In 2022, Chines increased the number of automobile purchases by 10% to 23 million. The United States purchased about 10 million vehicles. A decline in German automobile manufacturing likely means a decline in the volume of auto purchases in both China and the United States.
How Have Higher Interest Rates Impacted German Output?
The European Central Bank played a large role in the recent decline in German Industrial Production. Like many other global central banks, the ECB, started to raise borrowing rates in 2022 to reduce elevated inflation. The European Central Bank has a 2% inflation target and has raised rates to reduce current inflation levels back to their target range. German inflation in April was 7.2% year over year, much higher than the target range, and the ECB’s mandate allows them to raise rates to fend off future inflation. The result of higher borrowing costs is lower customer spending which spills over into lower industrial production. Higher rates have also buoyed the U.S. dollar, putting downward pressure on several commodity prices.
The Bottom Line
Economic cycles usually begin in recession. Industrial output declines, and growth sags. Recessions are usually caused by central banks, which have a mandate of price stability. One of the results of higher rates is lower growth and usually declining employment. German industrial output is contracting, and growth is slowing as higher interest rates have started to choke off economic growth.
Lower growth and contracting industrial output have had an impact on commodity prices. Lower output means less commodity demand, including Aluminum, steel, and energy. The result is that lower industrial output usually hurts commodity prices.