• KfW economists expect gross domestic product to grow by 0.7 per cent in 2026
• Federal Government’s fiscal package will likely provide positive impetus this year and, above all, in 2027
• Inflation is forecast to hit 3.1 per cent this year

The German economy started off the year with a solid growth rate of 0.3 per cent on the final quarter of last year. In the ranking of the large euro area countries, Germany thus moved up to second place in the first quarter behind Spain, whose economy grew 0.6 per cent on the previous quarter. But now the Iran war has clearly soured the economic outlook. KfW’s economists have once again moderately revised their growth forecast for this year downward to now 0.7 per cent (February forecast 1.5 per cent; April forecast 0.9 per cent). KfW’s growth forecast for 2027 is 1.3 per cent (February forecast 1.8 per cent, April forecast 1.4 per cent).

The main reason for the still significantly positive growth expectation for the year as a whole and, above all, for 2027, is the Federal Government’s fiscal stimulus. Defence spending in particular increased rapidly already in 2025 and has filtered through to German manufacturers in the form of orders for armaments. In recent months, however, funds from the Special Fund were disbursed slightly more slowly, although KfW Research still expects disbursements to pick up again from the second half of the year.

Thus, government investment and consumption in particular can be expected to make positive contributions to growth in 2026. But this should have an indirect effect on household consumption as well. KfW Research does not expect corporate investment and residential construction investment to make positive contributions to gross domestic product (GDP) across the year until 2027.

“The Iran war delivered a brutal rabbit punch to the German economy. What matters most now is that the Strait of Hormuz be opened again. We expect that to happen by around the end of June. It would gradually reduce energy prices. The growth rate of the German economy is then likely to turn positive again in the third quarter,”

said Dr Dirk Schumacher, Chief Economist of KfW. KfW Research expects a moderate drop in GDP for the second quarter.

KfW Research has also downgraded its forecast for the euro area. Its economists predict a growth rate of 0.6 per cent for 2026 (February forecast 1.4 per cent) and 1.0 per cent for 2027 (February forecast 1.8 per cent).

The sharp increases in energy prices as a result of the Iran war have had a noticeable impact on inflation. The cost shock will likely take time to filter through to further areas such as food. KfW Research has therefore lifted its inflation forecast. Its economists now expect an inflation rate for this year of 3.1 per cent for Germany and 3.0 per cent for the euro area. In the coming year, consumer prices are likely to continue rising more strongly than desired by the European Central Bank (ECB), increasing by 2.4 per cent in Germany and 2.3 per cent in the euro area. There are signs that the ECB will respond to the situation by moderately tightening monetary policy.

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