KfW Research - KfW Business Cycle Compass: German economy to grow at a slow pace after a difficult winter

• KfW Research expects GDP growth to settle in at 0.3% in 2024 and accelerate to 1.2% in 2025

• Inflation to drop from an average 2.5% in 2024 to 2.0% in 2025

• Ecological price tag for GDP: Greenhouse gas emission caps will likely be met in the 2023 to 2025 period

After a long period of stagnation, Germany’s economic output shrank noticeably in the final quarter of 2023. Important monthly indicators such as production remained weak in December, and sentiment clouded over yet again in January. But after stagnating in the first quarter of 2024, the economy is likely to gather steam again in the course of the year. KfW Research expects German GDP to grow by a moderate 0.3% in all of 2024 (previous forecast: +0.6%). GDP growth is likely to accelerate to 1.2% in 2025 (initial forecast). Since the weak economic environment gives businesses limited scope for enforcing price increases, the rise in consumer prices is likely to slow down further. KfW Research continues to forecast an inflation rate of 2.5% for Germany in 2024 (HCPI) and 2.0% next year (initial forecast).

“Despite the difficult winter, we maintain our expectation that the German economy will at least grow moderately again in all of 2024”,

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

“Given the falling rate of inflation, increasing nominal wages, almost steady employment as a result of growing skilled labour shortages and a rebound in global trade, the conditions for a household consumption- and export-driven recovery this year remain intact. These are the silver lining on the horizon, and they are likely to kickstart the economy little by little from the spring.”

Public sector consumption expenditure is likely to pick up again in 2024, after falling in 2023 for the first time since 2004 as a result of the end of state-funded pandemic measures. Furthermore, the European Central Bank and other globally important central banks can be expected to lower key interest rates in the later part of the year. The tightening of interest rates of the past years is likely to lead to another drop in highly interest rate-sensitive residential construction investment in 2024 due to the delayed effect of monetary policy. The high need for energy transition projects, however, is likely to stabilise business investment, while higher defence spending will drive public sector investment. Exports are also likely to rebound along with global trade in the course of the year and grow again across 2024.

Given the numerous crises and great challenges, the return to growth this year and next is grounds for hope. In the medium to long term, transitioning the economy and society to carbon neutrality will likely be the greatest of these challenges. According to the Ecological Price Tag for GDP, the new indicator which KfW Research introduced in the autumn of 2022, our current economic forecast implies that greenhouse gas (GHG) emissions will continue to decline. The annual caps on GHG emissions that are to be newly introduced for the current decade under the planned revision of the Federal Climate Change Act will presumably be met in the forecast period of 2023 to 2025. Nonetheless, the urgency to act on climate change remains high so that the GHG reduction target of 65% can also be met by 2030 and the long-term goal of climate neutrality by 2045, particularly in buildings and transport.

For the euro area, KfW Research predicts slow growth in the first quarter of 2024 which is then likely to pick up in the course of the year. All in all, GDP growth of 0.6% can be expected for 2024 (previous forecast: +0.8%), while growth is set to accelerate to 1.5% in 2025. The inflation rate in the euro area will likely remain unchanged from the previous forecast at 2.3% in 2024, before dropping to 2.0% in 2025 (initial forecast).

The current KfW Business Cycle Compass is available at­ www.kfw.de/konjunkturkompass