KfW Research: First silver lining on the horizon for the German economy

• After a 0.4% contraction in 2023, 0.6% GDP growth predicted for 2024
• German inflation to hit 6.1% in 2023, 2.5% in 2024
• Ecological price tag: Greenhouse gas emissions to exceed reduction target by around 5% in both 2023 and 2024

Although the German economy is likely to roughly stagnate over the course of 2023, the real GDP growth rate for all of 2023 will be moderately negative. In its current autumn forecast, KfW Research expects GDP to contract by 0.4% this year on the previous year, confirming the previous forecast. Two statistical effects will play a decisive role in this: First, the statistical underhang resulting from the sharp drop in GDP in the final quarter of 2022, which caused this year’s economic growth to start from a level that was 0.2% lower than the average across all four quarters of 2022. This deficit would have had to be balanced out first before generating any growth at all in 2023 on the previous year. Furthermore, the year 2023 has two fewer working days on which to generate GDP than 2022, which in itself reduces annual growth by around 0.2 percentage points as a negative calendar effect.

In 2024 the German economy should then return to moderate real growth with slightly increasing quarterly rates from the spring. The business cycle will be bolstered particularly by gains in household purchasing power, which will kickstart consumption in the course of the year. The recovery of consumption, however, will commence a bit later than was predicted in the summer, so that KfW Research has revised its GDP forecast for 2024 downward slightly to 0.6% (previous forecast: +0.8%). The rebound in purchasing power will be backed by rising nominal wages and a sharp drop in inflation. KfW Research expects the German inflation rate (HICP) to drop from 6.1% in 2023 to 2.5% in 2024.

“Rising real wages and steady employment will let wages rise tangibly also in real terms in 2024, giving households added purchasing power which they can use for consumption purposes. The return to a consumption-based and at least moderate growth is, after all, a first silver lining on the horizon, considering the numerous crises and great challenges facing the German economy”,

said Dr Fritzi Köhler-Geib, Chief Economist of KfW.

In the medium to long term, transitioning the economy and society to carbon neutrality will likely be the greatest of these challenges, as the pressure to take action on climate change remains high. According to the ecological price tag for GDP, the new indicator we introduced in late 2022, the current economic forecast implies that greenhouse gas emissions both this year and next will be around 5% higher than would correspond with the interpolated target trajectory of a 65% reduction by 2030 against the 1990 baseline.

To be sure, the monetary policy-induced interest rate rises and the more pessimistic business expectations are weighing on corporate investment. Nonetheless, they will grow both this year and next. There is an urgent need for investment, especially around the energy transition, climate neutrality and digitalisation, which can be tackled more vigorously now that the capital goods manufacturers that were paralysed by supply chain disruptions are sufficiently able to deliver again. Construction investment, particularly in dwellings, can be anticipated to continue decreasing, since that is where the sharply higher financing costs resulting from the European Central Bank’s interest turnaround are felt particularly acutely.

KfW Research predicts real GDP growth of 0.5% for the euro area this year (previous forecast: +0.7%) and 0.8% next year (previous forecast +1.0%). We expect an inflation rate (HICP) there of 5.5% in 2023 and 2.3% in 2024. As in Germany, real wage increases combined with a steady employment situation are also key to boosting euro area consumption, which will expand as inflation continues to fall.

Besides geopolitical and geoeconomic risks in connection with Russia’s invasion of Ukraine, the Middle East conflict and tensions between China and Taiwan, shortages and abrupt price increases in the energy markets remain among the greatest risks to the economic forecast. Uncertainties also remain about the impact of monetary tightening.

“However, there is also potential for the economy to develop better than expected. If global inflation falls faster than expected and interest rates can also be reduced sooner as a result, that will benefit Germany’s economy in particular. After all, Germany specialises in the manufacture and trade of high-quality capital goods”,

added Köhler-Geib.

The current KfW Business Cycle Compass is available at
KfW Business Cycle Compass | KfW