Germany Enters Recession in Blow to Europe’s Economy

Germany slipped into recession during the first three months of the year, as households cut spending in response to sharply higher prices for energy and food.

With Europe’s largest economy now having shrunk for two quarters in a row, meeting the technical definition of a recession, the eurozone as a whole may also have also contracted in the first quarter.

The development doesn’t fundamentally alter economists’ views about the country’s immediate prospects, and any decline in output in the broader region is likely to have been modest.

Still, a recession in the eurozone would deflate some of the optimism that has built up around the currency area’s economic prospects in recent months. It could also inspire greater caution among policy makers at the European Central Bank as they prepare to raise interest rates further.

“A technical recession would be a change in the overall narrative on how resilient the eurozone economy has been over recent quarters,” said Bert Colijn, an economist at ING.

Germany’s statistics agency said Thursday that gross domestic product—a broad measure of the goods and services produced by an economy—was 0.3% lower in the three months through March than in the final quarter of last year. It had previously estimated that the economy flatlined in the first quarter, having contracted by 0.5% in the final quarter of last year.

The agency said a 1.2% fall in household consumption was the main reason for the contraction, as households saw their spending power eroded by a surge in food prices. In March, German households were paying 21.2% more for their food purchases than a year earlier.

In the months immediately following the invasion of Ukraine, economists had warned that Germany faced a high risk of sliding into recession, given its reliance on Russian supplies of natural gas. But economic data releases at the turn of the year appeared to indicate that Germany would avoid that fate.

The revised figures for the first quarter confirmed that the world’s fourth-largest economy had succumbed to recession, but one less severe than feared when the Kremlin cut gas supplies in summer 2022.

Business surveys have pointed to a return to growth in Germany during the second quarter. But the impact of higher borrowing costs and a weak expansion in many of its main export markets point to the possibility of a renewed contraction in the three months through September.

“Higher interest rates will continue to weigh on both consumption and investment and exports may also suffer amid economic weakness in other developed markets,” said Franziska Palmas, an economist at Capital Economics who expects declines in GDP during both the third and fourth quarters.

Should the estimates for growth in other eurozone members be unchanged, the new measure of GDP for Germany suggests the currency area’s economy as a whole contracted slightly in the first quarter. The European Union’s statistics agency currently estimates it grew at an annualised rate of 0.3%, after shrinking by 0.2% in the final quarter of last year.

While that change in measured output would be small, it may have an influence on the ECB’s interest rate decisions over coming months. The ECB’s economists raised their growth forecasts for this and subsequent years in March, partly in response to a picture of the eurozone economy at the turn of the year that now appears overly optimistic.

The International Monetary Fund (IMF) has described the global economy as “surprisingly resilient” amid rapid interest rate rises to quell high inflation since 2022, post-pandemic supply chain disruptions, a short-term spike in energy prices due to the war in Ukraine and increased geopolitical tensions involving China and the Middle East.

The IMF’s biannual World Economic Outlook report says the world has so far avoided stagflation and recession, with large pandemic savings enabling households to cope with higher rates and inflation, and strong immigration in advanced economies creating unusually tight labour markets.

IMF economic counsellor Pierre-Olivier Gourinchas said most indicators point to a soft landing for the global economy and the IMG now expects “less economic scarring from the pandemic”. He noted that markets had reacted exuberantly in recent weeks to the prospect of central banks lowering interest rates soon.

However, the IMF says global growth will moderate over the next five years to its lowest level in decades. It projects 3.2 percent global growth in 2024 and 2025, the same pace as 2023, with still-high borrowing costs, the withdrawal of fiscal support and weak productivity growth weighing economic activity down.

Australia is expected to underperform other advanced economies, especially the United States, this year but will surge beyond them from 2025. The IMF predicts annual gross domestic product (GDP) growth of 1.5 percent in Australia in 2024, which is well below our long-term pre-pandemic average of 2.5 percent. The US is expected to book above-average growth of 2.7 percent in 2024 and the world’s advanced economies are tipped to average 1.7 percent growth.

Australian economic growth will then move above other advanced economies and maintain upward momentum through til 2029. The IMF predicts 2 percent GDP growth for Australia in 2025 and 2.3 percent in 2029. For the US, the IMF expects 1.9 percent growth in 2025 and 2.1 percent in 2029. For the advanced economies in aggregate, the IMF forecasts 1.8 percent growth in 2025 and 1.7 percent in 2029.

The IMF said higher interest rates had had less effect on the US economy compared to Australia because most US mortgages are on long-term fixed rates and household debt has been lower since the global financial crisis. In Australia, most loans are on variable rates and therefore immediately impacted by every rate rise, household debt is high, and housing supply is restricted.

“The exceptional recent performance of the United States is certainly impressive and a major driver of global growth, but it reflects strong demand factors as well, including a fiscal stance that is out of line with long-term fiscal sustainability,” said Mr Gourinchas.

An example of unusual fiscal policy is the Inflation Reduction Act, which includes US$369 billion in new spending to encourage green energy investment. “This raises short-term risks to the disinflation process, as well as longer-term fiscal and financial stability risks for the global economy since it risks pushing up global funding costs,” he said.

While things are going well now, Mr Gourinchas said risks to global economic progress remain.

“On the downside, new price spikes stemming from geopolitical tensions, including those from the war in Ukraine and the conflict in Gaza and Israel, could, along with persistent core inflation where labour markets are still tight, raise interest rate expectations and reduce asset prices. A divergence in disinflation speeds among major economies could also cause currency movements that put financial sectors under pressure.”

Mr Gourinchas said growth in China could falter, hurting trading partners, without a comprehensive response to its property sector downturn. “Domestic demand will remain lacklustre for some time unless strong measures and reforms address the root cause. Public debt dynamics are also of concern, especially if the property crisis morphs into a local public finance crisis.”

He also noted that weak productivity growth remains a challenge for the whole world and “much hope rests on artificial intelligence delivering strong productivity gains in the medium term”.

Germany Enters Recession in Blow to Europe’s Economy

Second straight quarter of contraction in eurozone’s largest economy might prompt greater caution by central bankers

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