Germany’s economy to shrink in 2023

Germany, Europe’s economic juggernaut, finds itself at the epicentre of a gloomy economic forecast, as the European Commission, the EU’s executive arm, anticipates a prolonged recession for the nation in 2023. This unsettling prognosis positions Germany as the sole major European economy grappling with economic contraction amidst a broader European landscape of cautious growth.

The Commission’s latest projections reveal a stark outlook for Europe’s largest economy, with a forecasted decline in economic activity by 0.4% this year. This somber forecast represents a downgrade of 0.6 percentage points from the Commission’s previous estimate issued in May. The outlook for 2024 is equally disheartening, with growth expectations for Germany slashed from 1.4% to a modest 1.1%.

The root of Germany’s economic turmoil can be traced to the reverberations of Russia’s invasion of Ukraine, which prompted Berlin to swiftly extricate itself from years of energy dependency on the Kremlin. The International Monetary Fund (IMF) echoed these concerns in July when it anticipated a contraction of 0.3% for Germany in 2023.

Eminent economists have resurrected the moniker “sick man of Europe” to characterise Germany’s current economic predicament. This phrase, first coined in 1998 during a period of profound economic challenges, has now resurfaced as Germany contends with substantial declines in output.

Yet, dissenting voices argue that comparing today’s economic challenges to those of the past is an oversimplification. Holger Schmieding, Chief Economist at Berenberg, emphasised the significant differences, citing record employment levels, robust labor demand, and a robust fiscal position, all of which place Germany in a more favourable position to navigate contemporary shocks.

The sobering economic outlook extends beyond Germany’s borders, encompassing a broader European slowdown. The European Commission’s forecasts indicate that the 27 EU economies are poised to register a collective growth rate of 0.8% for this year, marking a decline from the 1% estimate offered in May. The 2024 prognosis for the EU also paints a less optimistic picture, with growth now expected to reach 1.4%, down from the earlier projection of 1.7%.

One prominent factor contributing to this subdued economic performance across the region is persistently high inflation. The Commission identifies weak domestic demand, particularly in consumption, as a consequence of elevated consumer prices for most goods and services. These price pressures have proven more enduring than initially anticipated.

While the latest forecasts anticipate a gradual decline in consumer prices in the coming months, they are still poised to remain above the European Central Bank’s target of 2% by the end of 2024. Within the euro area, encompassing 20 EU nations sharing a common currency, headline inflation is projected to reach 5.6% in 2023 and then recede to 2.9% by the conclusion of 2024.

The Commission underscores that inflation in the services sector has exhibited a notable degree of persistence. However, it anticipates moderation in the face of tightening monetary policies and the waning influence of post-COVID stimulus.

As Europe grapples with these economic headwinds, attention turns to the European Central Bank (ECB), which is set to convene and announce its stance on interest rates. Since July 2022, the ECB has aggressively increased rates by 4.25 percentage points in a bid to combat historically elevated inflation. The central bank’s decision on further rate adjustments will be closely monitored as Europe strives to regain its economic equilibrium in the face of challenging conditions.