Germany's Economic Recovery Faces Challenges
Germany's economic recovery has been weaker than anticipated in the spring, according to experts at the German Institute for Economic Research (DIW). The institute has significantly reduced its growth forecast for the current year to just 0.5 percent. This adjustment highlights the ongoing challenges facing the country's economy.
Geraldine Dany-Knedlik, the chief economist at DIW, points to the energy price shock as a major factor slowing the recovery. However, she emphasizes that the current situation is not similar to the one experienced during 2022/23, when Russia launched its full-scale invasion of Ukraine. "The shock is smaller, energy supplies are still secure, and Germany is now less dependent on fossil fuel imports than it was after the start of the war in Ukraine," she explains.
Dany-Knedlik also notes that the only reason the economy is growing this year is due to public spending. Household demand is weakening, and companies have become more cautious. Rising government expenditure, such as increased defence spending and funds from a special budget, is helping to sustain economic growth.
Government Adjusts Growth Forecasts
The government had already revised its growth forecast in its spring projections. Initially, it expected growth of 1.0 percent, but by the end of April, it was only anticipating 0.5 percent. This aligns with the estimate from the Kiel Institute for the World Economy (IfW). While the federal government acknowledges that private consumption remains a key pillar of the economy, it also highlights the importance of public investment in driving growth.
Stability through defence spending Rising defence expenditure and, with a time lag, funds from the special budget for infrastructure and climate neutrality are supporting the German economy and ensuring modest growth in both forecast years, according to the DIW.
However, these fiscal policy impulses do not fully offset the cyclical downturn, Dany-Knedlik adds. "What matters is that the resources from the special funds are disbursed quickly and genuinely on top of existing budgets, rather than merely financing investments that were planned anyway."
Structural Challenges in the Economy
The DIW identifies other problems facing the German economy as 'structural'. Industry is no longer as competitive as it once was, particularly the automotive sector, which is under pressure. High production costs and demographic changes are also affecting competitiveness. According to the institute, these factors limit growth potential and make a rapid cyclical recovery more difficult, regardless of the current geopolitical situation.
International Outlook
Internationally, the DIW forecasts that the United States, as a major energy producer, will continue to post relatively solid growth rates of just over 2 percent, while the outlook for the euro area is significantly weaker. The US has become one of the world's largest exporters of liquefied natural gas (LNG) and is benefiting from higher gas prices. In contrast, Europe has to import its energy, leading to price shocks that weigh on the economy and erode purchasing power.
The DIW does not expect a supply shock, arguing that security of supply for oil and gas is not at risk, particularly thanks to a diversified setup. However, highly energy-intensive sectors such as chemicals, steel, and paper are suffering from rising electricity and gas prices. On DIW assumptions, this means Germany is being hit harder than other European countries.
Fiscal Policy and Inflation
Expansionary fiscal policy has cushioned the higher inflation, but it is not delivering the desired growth. Consumers are feeling the impact of higher energy costs in their daily lives, leaving less money for private consumption. The ifo Institute notes this in its Joint Economic Forecast for spring 2026. It remains unclear whether the European Central Bank will respond with an interest rate hike.
This is a problem, as the government currently regards consumption as one of the key drivers of growth in the German economy. The DIW takes a more critical view, arguing that growth is due solely to the public sector.
Labour Market Shifts
Structural changes in the labour market are also playing a role. Jobs are being cut in manufacturing and retail, while employment in the public sector is steadily increasing. The structural shift towards services is evident, but the overall number of people in work is declining.
Employers, trade unions, and the leaders of the governing coalition are meeting at the chancellery today to discuss reforms. The social partners were asked in advance, among other things, to prepare their views on the key factors behind Germany's persistent structural growth weakness.
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