German economy surges at fastest rate in five years

By Michael Nienaber and Joseph Nasr

BERLIN (Reuters) - The German economy expanded at the fastest pace in five years in 2016 and the growth momentum is expected to continue this year as rising private and state spending help Germany cement its position as the locomotive of the euro zone.

Europe's largest economy expanded by 1.9 percent last year, a preliminary estimate from the Federal Statistics Office showed on Thursday, as an environment of low interest rates and a record influx of refugees fuel household and state spending.

These factors have compensated for weakening exports, long the pillar of an economy where manufacturing makes up about a fourth of output.

Economists polled by Reuters had expected growth in gross domestic product (GDP) of 1.8 percent for 2016 after an expansion rate of 1.7 percent in the previous year. The growth rate of 1.9 percent matched the highest forecast in the poll.

The Statistics Office said it estimated growth was around 0.5 percent for the fourth quarter after it halved to 0.2 percent in the July-September period. The Ifo institute said it forecasts a growth rate of 0.5 percent January-March this year.

"The German economy in 2016 once again defied an entire series of downside risks, thanks to strong domestic demand," said ING economist Carsten Brzeski, adding that Germany's biggest risk now was complacency.

A breakdown of the 2016 GDP figures showed private consumption rose by an adjusted 2.0 percent on the year, contributing 1.1 percentage points to the overall growth rate.

STRONGEST SPENDING SINCE 1992

State spending jumped by 4.2 percent, adding 0.8 percentage points to the overall growth rate.

"This was the strongest increase in state consumption since 1992 following German reunification," the head of the Federal Statistics Office Dieter Sarreither said, adding this was due to spending on refugees as well as increased pension entitlements.

Economists expect the growth momentum to continue this year, although most forecasts point to a weaker expansion due to calendar effects.

"Taking a glimpse into 2017, the German economy remains fundamentally in good shape," said UniCredit's Andreas Rees. "The growth drivers will change somewhat, since there will be a (moderate) shift from domestic demand to stronger export activity." He expects growth of 1.5 percent this year.

The German economy ministry said incoming orders and sentiment indicators point to solid growth in production and a good start for this year.

"Overall, the picture of a solid, strong, domestically driven economy remains," it said in a monthly report.

Despite the optimism, economists and industry leaders warn that risks remain.

Rising inflation fuelled mainly by higher oil prices is expected to eat into the purchasing powers of Germans this year, restraining the growth impetus from consumption. State spending could also shrink as refugee arrivals fall.

In addition, the possibilities of a protectionist trade policy by U.S. president-elect Donald Trump and state interference in China have been cited as events that could hurt German exporters.

COMPANIES INVESTING LITTLE

Still, the German GDP data reinforces expectations that euro zone growth, which stood at 0.3 percent in the second and third quarter of last year, accelerated in the last quarter.

Better-than-expected industrial output data for Italy and the euro zone as a whole, published on Thursday, heightened expectations.

The European Union's statistics office Eurostat said industrial production in the 19-country single currency bloc rose by 1.5 percent during the month, and by 3.2 percent year-on-year. Both figures were much higher than market expectations.

Industrial output in Italy increased 0.7 percent in November following a marginal 0.1 percent gain in October, data showed.

A sustained recovery in the euro zone is good news for the German economy.

But economists say the government could turn the growth momentum into a longer term solid expansion by implementing structural reforms and increasing investments on infrastructure, digitalization and education.

Such suggestions are likely to face resistance from Finance Minister Wolfgang Schaeuble who said on Thursday he wants to use the 6.2 billion euros budget surplus in 2016 on amortizing debt.

His focus on austerity, coupled with mounting political risks that are clouding the outlook for exporters, make it unlikely that German companies sitting on billions of euros will boost investments.

Thursday's data showed that investment in machinery and equipment contributed only 0.1 percentage points to overall growth and imports rose more than exports.

Graphic on euro zone economy http://tmsnrt.rs/2bkCt7Q

Graphic on major European economies http://tmsnrt.rs/2bGaKmZ

(Additional reporting by Madeline Chambers and Paul Carrel in Berlin, Gavin Jones in Rome and Francesco Guarascio in Brussels; Writing by Joseph Nasr)