Germany's Economic Outlook

FRANKFURT (Reuters) – Germany's economy will shrink for the second year in a row this year, with slow recovery expected, exacerbated by a potential trade war with the U.S., according to Bundesbank President Joachim Nagel.

As the largest economy in the euro zone, Germany has faced challenges due to a loss of access to cheap Russian energy and a decline in export demand from China. The German economy is anticipated to stagnate through the winter, with a modest recovery driven by a smaller-than-expected rise in private consumption, a weakening labor market, and slow business investment recovery.

Nagel highlighted that the German economy is grappling with persistent economic challenges and structural issues. The labor market is responding noticeably to ongoing economic weakness. The Bundesbank now projects a contraction of 0.2% for the German economy this year, a revision from a previous forecast of 0.3% growth, while the 2025 growth outlook has been reduced from 1.1% to 0.2%.

The Bundesbank warns that these projections may be overly optimistic, given the risks from growing protectionism, geopolitical tensions, and structural changes affecting the German economy.

Simulations regarding increased tariffs from the Trump administration indicate that while the U.S. would face the most significant growth decline, Germany could see a 1.3% to 1.4% loss in output through 2027.

Inflation impacts from these tariffs are less certain, with the Bundesbank estimating a modest increase of 0.1% to 0.2% a year until 2027. Conversely, the National Institute Global Econometric Model anticipates a more substantial inflation hit of 1.5% next year and 0.6% in 2026.

The Bundesbank has indicated that current risks to economic growth are skewed toward the downside, while risks to inflation are tilted to the upside. With federal elections approaching, the fiscal landscape may also shift.

This persistent economic weakness has prompted the European Central Bank to lower interest rates and suggest further easing measures, as inflation concerns ease and the focus shifts to stimulating growth. However, the Bundesbank cautioned against declaring an end to inflation worries, noting potential spikes in food prices and sustained elevated services inflation, keeping price increases above the euro zone's average.