Shrinking economy prospects: Is another contraction on the horizon?
Germany's Economic Outlook for 2025: A Stormy Seas Ahead
The horizon for Germany's economy isn't exactly sunny: Despite a slight growth spurt in the first quarter after two years of recession, things aren't looking peachy for Germany, the export powerhouse, in 2025. The trade policies of the current U.S. President, Donald Trump, are a significant part of this gloomy forecast.
The State of the German Economy
There's a glimmer of hope in the early months of the year, with signs of improvement in industrial production, construction business, and retail sales. Preliminary figures from the Federal Statistical Office suggest a 0.2% increase in GDP. However, this optimism may be short-lived, given the shifting trade landscape.
"Germany's economic landscape is likely to remain tense, particularly due to the escalating trade tensions and the uncertainties that come with it," asserts the chief economist of the German Institute for Economic Research (DIW), Geraldine Dany-Knedlik. "We can only hope that Germany will now tackle its domestic problems more assertively and boost its sluggish investment in infrastructure and digitalization."
Prospects for the Future
Germany's largest economy could potentially experience a third consecutive year without growth - a historical first for the Federal Republic. Already low expectations have been revised downward repeatedly:
- The federal government predicts stagnation of the GDP (Gross Domestic Product) for the current year. Origially, they had hoped for a 0.3% growth.
- The International Monetary Fund (IMF) expects no growth for the German economy in the current year, attributing the global economic slowdown to Trump's aggressive trade policy.
- Bundesbank President Joachim Nagel predicts stagnation at best for 2025. He's not ruling out "the possibility of a slight negative sign, i.e., a small recession."
Key Challenges
Trump's "America First" policy has sent shockwaves through the global trade landscape. The historic burden of the XXL tariff package is only part of the problem; Trump's erratic policy course adds an extra layer of uncertainty: Some tariffs have already been temporarily suspended. "Exceptionally high uncertainty" was recently noted by ECB President Christine Lagarde.
Vincenzo Vedda, Global Chief Investment Officer at Deutsche Bank's fund subsidiary DWS, stated, "We had expected a turbulent start to Donald Trump's second term. However, we had not anticipated the U.S.'s isolation being pursued so unabashedly." Regardless of the future course of trade policy, "enough trust has already been eroded to make consumers, investors, and companies more reluctant."
The Future Government's Response
The Union and SPD have announced a host of measures aimed at stimulating the economy: Plans include better depreciation opportunities for companies, lower energy costs and corporate taxes, more flexible labor laws, and a reduction in bureaucracy. Costs for the expansion of renewable energies are to decrease.
Inflation in the Picture
Inflation has decreased for the second consecutive month in April, falling from 2.2% in March to 2.1%. However, the future of inflation remains unclear due to the trade dispute. Ravages in industrial goods could potentially lead to inflationary pressures. Furthermore, some economists fear that the planned massive billion-dollar spending by the federal government on defense and infrastructure could further fuel inflation.
The average inflation rate for 2022 was 6.9%, 5.9% for 2023, and 2.2% for 2024. While the inflation rate has dropped, consumers are still feeling the impact of the increased price level in their daily lives. Food prices have been escalating above average for months, while energy costs have decreased.
As inflation is also decreasing in the Eurozone, the European Central Bank has already lowered the deposit rate for banks and savers seven times since last June, to the current 2.25%. The ECB could further lower the rate this summer, which would mean lower interest rates for savers.
The Impact of Trump's Tariffs on Germany
Germany's export-driven economy is particularly susceptible to Trump's tariff blitz: The United States is Germany's most valuable trade partner, surpassing China and the Netherlands, and the largest buyer of German exports. In 2024, goods worth around 253 billion euros were traded between Germany and the United States. German exporters shipped goods worth over 161 billion euros to the United States, which is roughly 10% of total exports. For German exporters, the U.S. continues to be an essential market as it has been for the last 20 years.
Not All Industries Struggle Alike
While key industries such as automotive and machinery struggle, banks and insurers benefit from increased interest rates, leading to record profits for companies like Allianz, Munich Re, and Commerzbank. The pharmaceutical industry remains robust, drawing billion-dollar investments from abroad. Europe's largest software company, SAP, has seen a significant uptick in profits. However, the IT industry's overall economic impact on Germany is negligible. The same holds true for tourism, which recorded a record year in 2024.
A Silver Lining
The prospects for the German economy could drastically improve if the trade dispute with the U.S. is resolved. The European Union has already suspended planned counter-tariffs, anticipating negotiations. And Trump has at least offered automotive manufacturers tariff exemptions.
The domestic economy could also receive a boost from the federal government's billion-dollar package for defense and infrastructure - but not immediately. "Positive impulses will emerge from the future federal government's fiscal policy decisions, which will contribute to growth, but will only be noticeable in the coming years," asserts the outgoing federal government, which expects economic growth of 1.0% in 2026.
Enrichment Data:
Overview:
Germany is grappling with significant economic challenges in 2025, largely due to global factors such as the trade policies of the United States. While the current U.S. President at the time of these challenges is not Donald Trump but Joe Biden, the lingering effects of previous policies and ongoing global uncertainties continue to impact Germany. Here are some key challenges:
Economic Stagnation and Recession:
- Economic Forecast: Some forecasts suggest that Germany is in its third year of economic stagnation, with some predicting a contraction of 0.2% in GDP for 2025[6][8].
- Causes: The prolonged economic downturn is attributed to various factors, including domestic challenges and global uncertainties[7].
Trade Policy Impacts:
- Although the current U.S. president is Joe Biden, the ongoing repercussions of previous U.S. trade policies, including tariffs, continue to pose risks to global economic growth[7].
- These policies have contributed to a challenging trade environment, affecting Germany's export-oriented economy[8].
Domestic Challenges:
- Bureaucracy and Regulatory Hurdles: Excessive bureaucracy and lengthy approval procedures are hindering economic growth by increasing costs for businesses[7].
- Structural Change and Technological Shifts: The economy is undergoing significant structural changes due to efforts to reduce carbon emissions, demographic aging, and the adoption of artificial intelligence[7].
Labour Market and Investment:
- Labour Market Concerns: A weakened economic outlook is expected to lead to a higher number of unemployed people, potentially reaching 3 million by summer 2025[8].
- Investment Reductions: Many German companies are planning to cut investments and reduce their workforce, further complicating the economic recovery[8].
Fiscal Responses:
- Increased Military Spending: Germany has amended its Basic Law to allow increased defense spending to address geopolitical tensions, which could have fiscal implications[7].
- Special Funds: A special fund has been established for infrastructure and climate protection, aiming to stimulate economic growth and modernize public infrastructure[7].
- Stimulus Package: The Coalition government has announced a comprehensive economic stimulus package, including reductions in corporate taxes, energy costs, and bureaucratic hurdles to boost economic growth[7].
- Despite the slight growth in the first quarter of 2025, the German economy is likely to face challenges, particularly due to escalating trade tensions and the uncertainties they bring, according to the chief economist of the German Institute for Economic Research (DIW), Geraldine Dany-Knedlik.
- The financial sector, such as banks and insurers, could benefit from increased interest rates, leading to record profits for companies like Allianz, Munich Re, and Commerzbank, despite the struggles faced by key industries like automotive and machinery.
