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Bundesbank Forecast for Germany: German economy slowly regaining its footing

The Bundesbank sees the German economy slowly regaining its footing after a roughly two-year period of weakness. Not only will private consumption gradually pick up again, but export business will also improve again from the second half of the year. Against this backdrop, industry will also grow more strongly again. The German economy is extricating itself from the period of economic weakness,” Bundesbank President Joachim Nagel said on publication of the current Forecast for Germany. According to the forecast, real gross domestic product (GDP) will rise by a calendar-adjusted 0.3% this year, with the Bank’s experts anticipating economic growth of 1.1% next year and 1.4% in 2026. The Bundesbank is thus broadly confirming its December 2023 Forecast for Germany.

German economic output shrank by 0.5% in the fourth quarter of 2023, before expanding again by 0.2% in the first quarter of 2024. “In the short term, then, aggregate economic activity was somewhat weaker than expected in the Bundesbank’s December 2023 Forecast for Germany,” the authors report. They note that the sluggish demand in industry, in particular, proved to be more persistent than expected. Against this backdrop, and in the face of heightened economic policy uncertainty combined with heavy cost burdens, firms had throttled their domestic investment more sharply than anticipated. Energy-intensive sectors had supported industry, upping their output again noticeably for the first time since the start of the energy crisis, the economists explain. In addition, the construction sector proved more robust than expected.

Private consumption and exports drive economic recovery

GDP growth this quarter will probably be much the same as it was in the first quarter. The report indicates that the recovery among service providers should gain breadth and strength once private consumption starts providing stimulus again. An improvement in the ifo indicators for the business situation and their business expectations suggest that this will be the case. Business investment, on the other hand, will probably continue to decline at first. “For this reason, and given that the level of new orders remains weak, industry is not expected to stage a major recovery in the short term,” the authors warn. Nonetheless, they believe that production in energy-intensive sectors is likely to continue its upturn, and the automotive industry could already be providing a limited amount of growth stimulus as well. Economic activity looks set to shift up another gear in the third quarter, according to the experts. Consumer activity will then probably continue to solidify and industry, in particular, should provide stronger impulses.” The experts assume that the economy will grow at a somewhat brisker pace in 2025. Growth should then increase somewhat in 2026, with the economy more or less reaching its potential output again. The expansion will continue to be driven by private consumption and exports, to begin with. Private investment is not expected to provide any noticeable stimulus again before 2026. 

Consumer price inflation diminishes only slowly 

While the inflation rate in Germany is continuing to decline, the pace is subdued, the Bundesbank President said. The inflation rate as measured by the Harmonised Index of Consumer Prices (HICP) looks set to fall from an annual average of 6.0% last year to 2.8% this year. Energy and food price inflation in particular is expected to ease considerably in 2024, the authors note. However, inflation is proving to be stubborn, especially in the case of services, where strong wage growth and the resulting cost pressures are major factors. Negotiated wages are expected to rise particularly sharply this year, and will continue to see strong growth thereafter, the economists believe. The higher labour costs will also be reflected in food prices, especially next year. Energy price inflation should then also pick up again somewhat. 

The Bundesbank’s experts are expecting headline inflation to decline slightly to 2.7% in 2025, before dropping more sharply to an average of 2.2% in 2026. Meanwhile, core inflation (the rate excluding energy and food) is expected to decrease only hesitantly, falling to 3.1% this year, 2.5% in 2025 and 2.3% in 2026. The Forecast for Germany mainly attributes this slower pace of disinflation in the core rate to strongly rising labour costs. From 2025 onwards, negotiated wages will rise to a considerably lesser degree, but still see strong growth. Meanwhile, growth of actual earnings is projected to consistently remain somewhat above that of negotiated wages over the projection horizon.

Labour market tightness on the rise again 

Despite the ongoing weakness in the economy over the past two years, the labour market remained stable in the 2023-24 winter half-year. Employment is likely to carry on growing moderately for now. As the improvement in economic activity slowly takes hold, employees’ working hours are likely to be the first area to recover. Meanwhile, unemployment is likely to rise slightly for a few months more, before falling again slowly towards the end of the year, according to the experts. 

As of 2025, demographic developments are projected to limit the labour supply, with labour market tightness rising considerably again. Employment growth is expected to weaken slightly as supply bottlenecks increase, coming to a halt in the course of 2026. This is because the slight decline in unemployment in 2025 and 2026 will no longer open up any substantial scope for additional employment. As working hours per employee go up, the economic recovery will then be increasingly borne by rising labour productivity.

Improving public finances 

According to the Forecast for Germany, public finances are set to improve, with the government deficit ratio expected to shrink from 2.5% last year to 1.1% in 2026. Until 2025, this will be due to the expiry of fiscal crisis assistance measures. The decline in assistance will outweigh sharply rising expenditure in areas such as pensions, defence and staff. Beyond 2025, the relief for government finances will stem chiefly from slightly more restrained central government spending, including special funds, and a more favourable economic situation. The debt ratio is expected to fall to somewhat more than 60% by 2026.