Despite the energy crisis, the Deutsche Bundesbank does not expect the German economy to 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 the latest projections. The Bundesbank’s economists expect gross domestic product (GDP) to contract by 0.5% in calendar-adjusted terms next year, after probably expanding by 1.8% this year. They are projecting the German economy to grow by 1.7% in 2024 and by 1.4% in 2025. “Compared with the June projection, the rate of change in GDP for 2023 has been revised considerably downwards,” Mr Nagel said. Back then, the Bundesbank’s experts had still expected GDP to rise by 2.4% (2024: 1.8%). This was due to the assumption that there would be a massive deterioration in the supply of energy as a result of Russian gas deliveries coming to a complete halt, weaker growth in foreign demand and higher financing costs.

Economy will probably contract at first

The economic downturn will be the result of several factors. According to the report, households will be unable to consume as much due to the high rates of inflation. This will affect both retailers and other consumption-related service providers – such as the accommodation and food service sector, which includes restaurants and hotels. Furthermore, the Bundesbank’s economists explain that, as in other sectors, enterprises in the services sector will themselves be burdened by the high costs of energy. Thus, high energy costs will particularly weigh on energy-intensive industry, which includes the chemicals and glass industries, for example. High energy costs have also dampened exports in these sectors. According to the Bundesbank’s experts, the sharp rise in labour costs will place an additional burden on exporters’ price competitiveness. In addition, new orders from abroad have been trending downward for some time. Investment amongst enterprises and in housing construction is likely to tail of markedly at first. The Bundesbank’s economists also note that projects might be postponed or completely scrapped given the high degree of uncertainty regarding energy supply and its costs. Increased financing costs are likely to represent an additional burden.

“From the second half of 2023 onwards, the economy will recover”

However, according to the outlook, the German economy will gradually recover from the second half of 2023 onwards. The Bundesbank’s experts write that uncertainty will then abate, the inflation rate will fall and wages will rise sharply. The latter is partly because the labour market is likely to remain robust: “The high demand for labour compared with the labour supply suggests that the labour market will largely withstand the economic headwinds in the next few quarters,” they note. This means that many enterprises and businesses are still looking for employees, even though the economy is weakening. The experts explain that the prospects of finding a new position are very good for people who have lost their jobs. Thus, consumers will again have, in real terms as well, more money at their disposal to spend on goods and services. German exports, too, are projected to pick up again from the second quarter of 2023, if the headwinds caused by energy prices and supply chain pressures gradually diminish and demand for goods “made in Germany” rises again significantly. Investment should then also increase. “Investment in vehicles, in particular, could temporarily stimulate catch-up effects if supply bottlenecks are resolved,” the Bank’s economists add.

However, the experts explain that macroeconomic production capacity will not return to normal levels of utilisation until 2025. The fact that economic output will remain below its medium-term potential output until that time is not due to a lack of demand, however, but is instead the result of supply disruptions, especially with regard to energy. To a certain extent, these disruptions may be considered temporary, the Bundesbank’s economists write. Nevertheless, the experts do not expect that, in the long term, the energy supply costs will return to their levels from before the current crisis.

Inflation will decline only gradually

The report states that the energy crisis has also boosted inflation in Germany. 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. The inflation rate will then decline further – to 4.1% in 2024 and, finally, to 2.8% in 2025. In the June projection, the Bundesbank’s experts had still expected a rate of 4.5% for 2023 (2024: 2.6%). Thus, they revised their forecast upwards markedly again for all years. 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.

However, after the beginning of 2023, the inflation rate could then have already peaked and subsequently decrease significantly over time. According to the report, the government’s electricity and gas price brake will then significantly mitigate the rise in electricity and gas costs, for one thing. The Bundesbank’s experts also assume that oil prices will fall. Furthermore, from March 2023 onwards, the sharp rise in energy prices following Russia’s invasion of Ukraine will no longer impact the year-on-year rate. The gradual recovery is expected to continue into 2024 and 2025. Price inflation, however, will remain high. Although energy price inflation will likely decline distinctly due to falling energy commodity prices, it will remain perceptible – in part because there will probably be strong, rebound effects once the electricity and gas price brake expires. This means that consumer prices will be higher again because this government measure will no longer be available to ease the burden on households and enterprises. In addition, strong wage growth will push up prices. “This is one major reason why inflation excluding energy will be markedly above its longer-term average in 2024 and 2025,” the Bundesbank’s economists explain.

Projections amid major uncertainty

The Bundesbank’s 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.