Source: Deutsche Bundesbank
The war in the Middle East is weighing on the German economy and will initially slow down the recovery that began in the winter half-year. Nevertheless, Bundesbank President Joachim Nagel is confident: Economic activity will gain traction again over our forecast horizon up to 2028, he said upon publication of the Bundesbank’s new Forecast for Germany. The recovery will be supported by falling energy prices, a strengthening global economy and, above all, strong stimulus from fiscal policy.
In the summer half-year, expansionary fiscal policy will prevent a decline in economic output. It will more or less offset the impact of the war in the Middle East. The sharp rise in energy prices will dampen households’ purchasing power and consumption expenditure, Mr Nagel said. In addition to expensive energy, firms are also facing increasing supply bottlenecks and weaker demand. The high level of uncertainty and higher interest rates will be a drag on private investment as well. The impact of the war will fade over the forecast horizon, as oil prices are expected to go back down significantly.
Aggregate capacity utilisation will increase again
Against this backdrop, the Bundesbank’s experts project that calendar-adjusted real gross domestic product (GDP) will grow by 0.5 % this year and 0.8 % in 2027 in their current Forecast for Germany. As both years will have more working days than the year before, the unadjusted growth rates are somewhat higher, at 0.7 % and 0.9 % respectively. Economic growth will then continue with more momentum in 2028. The Bundesbank is projecting a (calendar-adjusted) growth rate of 1.4 %. “Aggregate capacity utilisation will gradually improve again,” Bundesbank President Nagel said. However, structural barriers, such as demographic pressure on the supply of skilled workers and non-wage labour costs, will continue to exist and will dampen potential growth. Bundesbank economists estimate that potential output will increase by only 0.3 % to 0.4 % per year over the forecast horizon. This means that the expected GDP growth rates distinctly outstrip weak potential growth thanks to expansionary fiscal policy in particular.
Inflation rate just below 2 % in 2028
Inflation risks have increased amid the war in the Middle East. The energy price shock is driving up inflation, Mr Nagel said. According to the Forecast for Germany, the inflation rate as measured by the Harmonised Index of Consumer Prices (HICP) will climb to 2.9 % this year and will fall only slightly to 2.7 % in 2027. It takes time for higher energy prices to be fully reflected in the cost of living – directly via higher energy costs and indirectly via rising transport costs, for example, Mr Nagel noted. As a result, not only headline inflation but also the core rate excluding energy and food will go up. Only in 2028 will inflation come down significantly to 1.9 %. The transition of the national carbon price to the EU Emissions Trading System (ETS2) will then also have a dampening effect. Even so, core inflation will still be comparatively high at 2.3 % in 2028. This is mainly due to the economic recovery and another stronger boost from unit labour costs.
If energy prices were to go up even more sharply than assumed in the forecast owing to developments in the Middle East, this could further amplify the general rise in prices whilst also significantly dampening economic activity. All in all, our new forecast is characterised by particularly high uncertainty given the geopolitical situation, Bundesbank President Nagel remarked.
The government deficit and debt ratios will rise significantly. Additional defence expenditure and non-military investment are not the only reasons. Others include various types of tax relief and transfers. Overall, the government deficit ratio will reach 4.9 % in 2028, and the Maastricht debt ratio will climb to almost 70 %.
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The Bundesbank’s Forecast for Germany: Energy price shock slowing down economic recovery | Inflation rising – expansionary fiscal policy supporting economic activity
