Germany faces economic contraction amid eurozone slowdown and inflation

Germany, Europe’s largest economy, is expected to shrink by 0.4% this year, according to the latest forecast by the European Commission. This is a sharp downward revision from the previous estimate of 0.2% growth in May.

The commission said that high inflation and rising interest rates have taken a heavier toll on consumer spending than expected, despite a strong labour market and declining energy prices. Consumer prices in Germany rose by 6.4% in August, the highest rate since 1993.

The commission also noted that Germany’s industrial sector, which accounts for about a quarter of its GDP, has been struggling with supply chain disruptions, labour shortages and environmental regulations. The country’s car industry, in particular, has been hit hard by the global semiconductor shortage and the shift to electric vehicles.

Germany faces economic contraction amid eurozone slowdown and inflation
Germany faces economic contraction amid eurozone slowdown and inflation

Eurozone growth outlook also downgraded

Germany’s economic woes are part of a wider slowdown in the eurozone, which is expected to grow by only 0.8% this year, down from 1.1% in May. The commission said that the eurozone’s recovery has been uneven and subdued, with some countries performing better than others.

France and Spain, for instance, have seen modest improvements in their growth prospects since the spring, thanks to a strong tourism season and robust domestic demand. France is expected to grow by 1.7% this year, while Spain is expected to grow by 2.1%.

However, other countries, such as Italy and Greece, have faced renewed challenges from the pandemic and political uncertainty. Italy is expected to grow by 0.5% this year, while Greece is expected to contract by 0.3%.

The commission also warned that the eurozone faces significant downside risks, such as the war in Ukraine, which could disrupt energy supplies and increase geopolitical tensions; the spread of new variants of Covid-19, which could undermine vaccination efforts and public health measures; and the possibility of a disorderly adjustment of financial markets, which could trigger a tightening of credit conditions and a rise in sovereign debt spreads.

Inflation eases slightly but remains above target

The commission said that inflation in the eurozone has eased slightly since the spring, but remains well above the European Central Bank’s (ECB) target of close to but below 2%. Inflation in the eurozone is expected to average 5.6% this year, compared with 5.8% in May.

The commission attributed the high inflation to temporary factors, such as rising energy and food prices, supply bottlenecks and base effects from last year’s low inflation. It said that inflation is expected to moderate in 2024, as these factors fade and monetary policy becomes less accommodative.

The ECB has raised its key interest rate from -0.5% to 3.75% in nine successive steps since November 2022, in an attempt to contain inflationary pressures and preserve financial stability. However, some analysts have argued that the ECB has acted too hastily and too aggressively, risking a premature end to the economic recovery.

Paolo Gentiloni, the EU commissioner for economy, said: “The EU avoided a recession last winter – no mean feat given the magnitude of the shocks that we have faced. This resilience, most evident in the strength of the labour market, is a testimony to the effectiveness of our common policy response.”

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