Germany’s Economic Landscape: Current Challenges and Future Outlook

12 Dec 2024 by rate3

Germany’s economic situation offers a complex landscape, reflecting a mix of cautious optimism and underlying challenges. The DAX recently closed marginally above the flatline at 20,429, extending its record high. This was achieved amidst a cautious sentiment in Europe as traders digested the latest monetary policy decisions from the European Central Bank (ECB). The central bank lowered interest rates by 25 basis points as expected, simultaneously reducing its GDP growth and inflation forecasts. This decision was widely anticipated, with traders only slightly increasing their bets on further easing expected by March. In the broader European context, the Swiss National Bank delivered an unexpectedly aggressive 50 basis point rate cut, dropping its key policy rate to 0.5%.

Among the notable gainers on the DAX, Airbus saw a 2.4% increase, while BMW rose by 2%, and companies such as Rheinmetall, SAP, and Adidas recorded gains of over 1%. Conversely, Munich Re led a poor performance for insurers with a 2% decline. In conclusion, while the DAX is at an all-time high, having doubled from its 202 levels, the outlook for shareholders in Germany remains relatively positive.

However, this upturn is juxtaposed against a backdrop of economic contraction. The gross domestic product (GDP) in Germany shrank by 0.3% year-on-year in the third quarter of 2024, matching the previous quarter’s pace and exceeding initial estimates of a 0.2% drop. This marks the fifth consecutive quarter of economic decline. While this lack of growth is troubling, it is notable that the contraction is quite minor in historical terms. For example, during the reunification period in 1993, the contraction reached -2%, and in the 2008 financial crisis, it dropped to -7%. Not to mention, there was a significant contraction of -11% in an enclosed area. In comparison, the contraction experienced in 1982 was about 1.5%, and in 1975, it was 2.5%. Thus, the recent downturn can be perceived as relatively small.

The labor market also reflects a mixture of stability and concern. The seasonally adjusted unemployment rate held steady at 6.1% in November 2024, matching expectations and remaining at its highest level since February 2021. The number of unemployed individuals increased by 7,000 to 2.86 million, which is notably below the forecasted rise of 20,000. As Andrea Nahles, head of the Labour Office, noted, “Economic weakness continues to weigh on the labor market.” Job demand showed further weakness, with 668,000 reported job openings in November, 65,000 fewer than a year earlier, indicating a continuing slowdown in hiring activity.

When we consider historical context, the current unemployment rate is comparable to levels seen in the 1990s and the post-war reconstruction of 1955 when it peaked at around 12%. Similar 12% rates were recorded in both 2007 and 1997. Thus, the current rate of 6% represents a moderate increase and is less than those recorded during any period between 1992 and 2017.

Inflation presents another layer of complexity. Germany’s annual inflation rate rose to 2.2% in November 2024, up from 2% in October, marking the highest level in four months. While services inflation held steady at 4%, energy costs declined at a slower pace, decreasing by 3.7% compared to a 5.5% drop in October. Additionally, food inflation slowed to 1.8% from 2.3% in the previous period. On a monthly basis, consumer prices fell by 0.2%, aligning with initial estimates following a 0.4% rise in October. Core inflation, which excludes volatile food and energy prices, reached a six-month high of 3%. In light of these data points, the EU-harmonized inflation rate remained stable at 2.4% annually. Month-on-month, harmonized consumer prices declined by 0.7%, reversing a 0.4% increase from the prior month.

In conclusion, the current inflation rate is negligible when compared to peaks reached in previous years: over 8% in 2022, over 6% in 1992, over 7% in both 1981 and 1973, and an alarming 11% in 1951. Thus, the current inflation situation is relatively favorable.

The benchmark interest rate in Germany, set by the European Central Bank, averaged 1.86% from 1998 until 2024. It reached an all-time high of 4.75% in October 2000 and a record low of 0.00% in March 2016. Currently, the rates are much higher than those seen between 2008 and 2022, which significantly suppressed the economy. This rate is comparable only to periods of economic turmoil in the late 2000s and early 2000s, suggesting that the interest rate might be one of the significant sources of current problems facing Germany today.

Another pressing issue is the government budget deficit, which equaled 2.50% of the country’s GDP in 2023. Historically, the government budget in Germany averaged -1.88% of GDP from 1995 until 2023, reaching an all-time high of 1.90% in 2018 and a record low of -9.40% in 1995. While the current budget deficit is an improvement compared to 2020, it marks a sharp reversal from the profitable policies that characterized the years between 2000 and 2020. This situation mirrors record deficits seen in 2008 (over 4%) and 1995 (over 10%). The budget deficit indicates that government expenditures have not been productive, primarily focusing on social measures that failed to propel society forward and strengthen the economy.

The Ifo Business Climate indicator for Germany decreased to 85.7 in November 2024, down from 86.5 in October and below forecasts of 86. The decline reflects a lack of government stability and the potential threat of trade tariffs from an upcoming Trump administration, both contributing to a deteriorating sentiment. The sub-index for current conditions worsened to 84.3, and business expectations edged down to 87.2. Ifo president Clemens Fuest noted, “The German economy is lacking strength. Companies were somewhat skeptical again about the coming months.”

The overall business climate has deteriorated significantly, especially in the manufacturing sector where companies expressed heightened skepticism about the months ahead. In the services sector, the business climate index dropped sharply, with companies expressing a much more negative view of the current situation. By contrast, the retail sector saw some improvement; however, optimism remains far from widespread. Comparing the current levels to the 2010–2020 average of above 100, the recent drop to 85 is reminiscent of the crises in 2008 and the reunification period in 1993. This decline reveals the substantial challenges facing SME policy in Germany, reflecting a broader issue where bureaucracy prevails over entrepreneurship.

Lastly, consumer sentiment also experienced a notable downturn. The GfK Consumer Climate Indicator fell to -23.3 points heading into December 2024, marking its lowest level since May and falling short of forecasts of -18.6, reminiscent of December 2023 levels. Income expectations dropped sharply, declining by 17.2 points to a nine-month low of -3.5, driven by recession fears, rising unemployment, and diminished growth forecasts. Concerns surrounding job security, industrial layoffs, and mounting insolvencies contribute to growing uncertainty. Furthermore, purchase inclination dropped by 1.3 points to -6, indicating a restrained consumer sentiment, even lower than early pandemic levels. Rising savings intentions increased by 4.7 points, compounding the already pessimistic outlook.

Overall, the economic indicators point to an environment filled with uncertainty and declining confidence, with growth forecasts for 2024 and 2025 remaining modest at just 0.4%. In conclusion, since the decisions made to shutter the economy in 2020 — allegedly for the sake of mythical security that can never be fully attained — the consumer climate has deteriorated sharply. Current levels are significantly lower than historical minimums of -2, observed in 2002. The drastic deterioration in consumer income reflects the ramifications of policies that did not take into account the long-term health of the economy.