Despite the energy crisis, the Deutsche Bundesbank expects that the German economy will not experience a severe downturn in the winter. “While economic output is likely to contract initially, we expect that the economy will gradually recover from the second half of 2023 onwards,” said Bundesbank President Joachim Nagel upon the release of its latest projections. However, the energy crisis will boost inflation in Germany. “Inflation is high and will decline only gradually,” Nagel explained. “According to our projection, the rate of inflation in Germany is likely to fall to 2.8% by 2025. With regard to the euro area as a whole, we must not let up our monetary policy efforts towards bringing inflation back down to our target of 2%.”

The Bundesbank’s economists expect gross domestic product (GDP) to contract by 0.5% next year, after probably expanding by 1.8% this year. According to their projections, the German economy will grow by 1.7% in 2024 and by 1.4% in 2025. Macroeconomic capacity utilisation is then likely to return to normal levels only in 2025.

The Bundesbank attributes the decline in economic activity expected up until the middle of next year primarily to the energy crisis caused by Russia’s war of aggression against Ukraine. Due to the high rates of inflation, household consumption will decline until mid-2023. Energy costs and weak foreign demand will weigh on exports. In addition, the elevated level of uncertainty and higher financing costs will depress investment amongst enterprises and in housing construction. As pandemic-related spending will come to an end, real government expenditure will also fall. The recovery expected from the second half of 2023 onwards is based on improvements among some of the stress factors. For instance, foreign demand is expected to rise, uncertainty will abate, price pressures from energy commodities will diminish, and the rate of inflation will fall. As the labour market will remain robust and wages will see strong growth, real household income and private consumption will then increase again.

Inflation rates remain high for now

The rate of inflation as measured by the Harmonised Index of Consumer Prices (HICP) is expected to be 8.6% this year. The Bundesbank’s economists expect it to fall to 7.2% next year, partly because of the government’s electricity and gas price brake. The inflation rate will then decline further to 4.1% in 2024 and, finally, to 2.8% in 2025. The HICP rate excluding energy and food will first continue to rise slightly next year, climbing to 4.3%, before subsequently falling to 2.6% in 2025. According to the Bundesbank’s projections, price inflation will remain high, mainly due to the pressure expected from labour costs and persistently large profit margins. In 2024 in particular, rebound effects following the expiration of the electricity and gas price brake will contribute to the elevated headline rate of inflation.

Government finances shaped by crises

According to the Bundesbank’s economists, public finances will be shaped to a large extent by the energy crisis. The government will provide substantial support to enterprises and households, especially in the form of broad-based subsidies and other transfers. At the same time, the measures related to the pandemic will come to an end. On balance, the deficit will rise from 2¾% of GDP this year to 4% next year. Thereafter, the support measures will be gradually phased out and the deficit will fall to around 1½% of GDP.

Comparison with June projection and risks

“Compared with the June projection, the rate of change in GDP for 2023 has been revised considerably downwards,” said Bundesbank President Nagel. This is due to the deterioration in conditions regarding the supply of energy, weaker growth in foreign demand, and higher financing costs. At the same time, the rates of inflation have been revised markedly upwards for every year.

The projections remain subject to an unusually high degree of uncertainty. According to the Bundesbank, the greatest uncertainties include further developments in the war in Ukraine and the energy crisis, the consequences of government countermeasures, and the impact of high inflation. The risks to economic growth are tilted predominantly to the downside, mainly due to potential shortages in the supply of energy. With regard to inflation, upside risks predominate.

Projection December 2022