Germany slips into recession

By Sarah

Germany, the 4th largest economy in the word, has entered a recession after experiencing 2 consecutive quarters of negative economic growth. In the 1st quarter of 2023, GDP contracted by 0.3%, following a fall of 0.5% at the end of last year. This is despite estimates it would avoid a recession with 0% growth in 2023.

What has caused the fall in GDP?

The primary cause of the recession is a fall in aggregate demand, mainly consumption. This is in large due to heavy inflation in Germany above the average of 7% inflation in the Eurozone. Rising prices reduces the amount of goods and services households can afford with their income, so is said to reduce ‘real’ incomes. As they can afford less, household spending has fallen by 1.2%. Many households must focus on affording basic necessities such as food, energy and rent, so do not have as much disposable income for extra consumption.

Additionally, energy prices have risen by 240% in Germany, which increases the cost of heating and electricity for households and further reduces their spending. This is due to the loss of supply of Russian oil after the invasion of Ukraine in March 2022. A lack of supply in the market means countries must offer higher prices to buy oil from other sources.

Furthermore, the war in Ukraine has caused significant uncertainty, which can be measured by the ifo business climax index for Germany. The index is takes 9000 monthly responses from business about their current situation and expectations for the next 6 months to give an early indication of economic developments. The graph above shows the rise in uncertainty felt by businesses during 2023. When businesses are uncertain about the future, they will cut back spending and investment, because they are unsure if they will see good profits. This means they will not increase output, and may even cut back to reduce costs, causing GDP to fall.

The ifo fell for the first time in 6 months (seen below) in May to 91.7 from 93.4 in April, when indexed against the average sentiments in 2013. This is due to pessimistic expectations of managers who are less satisfied with the level of incoming orders and demand in Germany. Manufacturing, trade and construction all saw steep declines, however the service sector remained unchanged.

What does the future look like for Germany’s economy?

Inflation is cooling, as it fell to 6.1% in May from 7.2% in April. This may increase consumer and business confidence, as long as it remains on a downward trend. Businesses however do not like change, so their confidence relies of inflation being steady and predictable.

There have been large investments into semiconductors and battery factories in Germany, which could lead to growth in the clean energy sector, however, is likely to take a long time to significantly impact the economy.

The Bundesbank (German central bank) is predicting an increase in growth in the second quarter of 2023, which would end the recession. This is a result of improvements to supply chain issues and firms now able to fill backlog orders from the pandemic. Predictions of growth and improvement are likely to improve confidence, which will enable growth to occur and likely lift Germany out of recession once again.

Overall, GDP is expected to shrink by 0.3% by the end of 2023, suggesting it won’t enter a deep recession. It is worth noting that 2/3 of the fall in GDP is put down to more workdays lost for public holidays in 2023 than previous years, showing confidence is likely on the way up in Germany.