Inflation and Energy Shocks Push Germany into Recession

Germany’s economy has sunk into a recession, as the ripple effects of the previous year’s energy price surge continue to influence consumer spending.

The first quarter of 2023 saw a 0.3% decrease in output in Europe’s biggest economy, coming on the heels of a 0.5% contraction at the end of 2022, according to official data released on Thursday by the Federal Statistical Office. This downward trend prompted a revision of the Federal Statistical Office’s earlier prediction of stagnant growth for the gross domestic product (GDP) compared to the preceding quarter.

The Impact of High Prices

The Federal Statistical Office explained that the lingering high price increases continued to strain the German economy at the start of the year. Household final consumption expenditure was particularly affected, down by 1.2% in the first quarter of 2023.

The chief euro area economist at Pantheon Macroeconomics, Claus Vistesen, ascribed the constrained consumer spending in the first quarter to the shock in energy prices. The European energy prices had already been increasing when the invasion of Ukraine by Russia in February the previous year sent them skyrocketing to unprecedented levels. Subsequent actions by Moscow to cut gas supplies to European nations pushed Germany to declare an emergency.

Uncertain Future

Despite natural gas prices dropping to late 2021 levels, a possible relief to consumers’ inflationary pressures, Germany’s annual inflation rate remained elevated at 7.2% in April, the first month of the second quarter. Vistesen predicts a rebound in consumer spending as inflation mitigates, but doubts a strong recovery for the GDP in the upcoming quarters.

Yet, there are signs that Germany’s recession might be temporary. Data from recent surveys indicated that German business activity resumed growth in May, despite manufacturing taking a hit. German Chancellor Olaf Scholz characterized the economy’s outlook as “very good,” citing his government’s recent efforts to enhance renewable energy production and attract foreign labor.

However, the senior Europe economist at Capital Economics, Franziska Palmas, forecasts that German output might contract further in the third and fourth quarters of 2023.

Trading Strains and Economic Predictions

Germany’s export-driven economy may suffer due to diminished demand from weakened economies in other developed nations. This comes in the wake of a 24% decrease in exports of German cars to China, Germany’s top trading partner, just above the United States, in the first quarter.

A report released by five German economic institutes in April 2022 had predicted a 2.2% GDP contraction for 2023 if Germany’s supply of Russian natural gas was cut off. This pessimistic forecast overshadows the International Monetary Fund’s latest projection of a 0.1% shrinkage in Germany’s economy for 2023.