KfW Research: The German economy is growing again

• Economic output has increased again since the start of the year, with 0.3% GDP growth predicted for 2024 and 1.2% for 2025
• German inflation to hit 2.6% in 2024 and 2.2% in 2025
• Ecological price tag: Greenhouse gas emissions are falling, limits will be complied with in 2024 and 2025

Germany’s economic output returned to moderate growth in the first quarter of 2024, after shrinking at the end of 2023 and virtually stagnating across the whole year. The leading indicators thus far available point to moderate growth for the second quarter of 2024 as well, and the upswing should broaden in the second half of the year. In its current spring forecast, KfW Research continues to predict growth of 0.3% for Germany in 2024, followed by 1.2% in 2025, confirming its previous forecast.

“The annual growth rate of 0.3% in our forecast for 2024 conceals more positive news than is apparent. The German economy is growing again and will presumably grow at an increasing pace in each quarter of this year as a result of the increasingly broader economic upswing from the middle of the year”,

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

“Because it started on a low level as a result of the contraction at the end of the previous year, growth will be very moderate, but we then expect 1.2% next year and similar cyclical momentum throughout the year. According to our forecasts, the annual rates – growth from Q4 to Q4 – will sit at +1.2% in both 2024 and 2025. However, tackling structural challenges remains a matter of great urgency, as otherwise the predicted growth rates for 2024 and 2025 will remain an exception and the transition to a digital and climate-neutral economy will be much harder.”

With inflation now on a moderate level amid significantly higher nominal wage increases, and with employment likely to remain steady amid skilled labour shortfalls, the conditions for a recovery driven by household consumption remain fulfilled. Public sector consumption expenditure is also likely to pick up again this year and next, after falling in 2023 for the first time since 2004 because of the end of state-funded pandemic measures, slowing down growth considerably. Furthermore, German exports can benefit from a recovery in global trade. However, since the rebound in spending in Germany is likely to lead to sharp growth in imports as well, external trade will probably provide only a minor boost to GDP growth up until the end of the forecast horizon.

Gross fixed capital formation, on the other hand, is expected to recover at a sluggish pace. To be sure, the ECB is now almost certain to begin lowering interest rates this summer, but the further loosening of monetary policy is likely to proceed only at a slow pace, and the monetary tightening of previous years will have a lingering effect. Particularly in private residential construction investment, which is highly sensitive to interest rate movements, a renewed sharp drop can be expected in 2024 despite the positive start to the year. By contrast, corporate investment is likely to remain roughly steady, in part because of the high investment needs of the energy transition, and public investment expenditure will likely increase mainly as a result of increased defence spending under the Special Fund for the Bundeswehr (Germany’s Armed Forces). The dampening effect of global monetary policy will then ease noticeably in 2025, however, benefiting the construction and manufacturing sectors in particular. Private residential construction investment will then also expand significantly again, propped up by continued high demand for housing.

In terms of inflation, an initially choppy sideways movement is to be expected for the coming months. The main reason for this is persistent services inflation, which recently stood at an uncomfortably high 3.6%. But the prospects for a further drop in services inflation are good because although collectively agreed wages in Germany rose again strongly in the first quarter, taking into account special payments, the continually falling increases in salaries offered in job advertisements suggest that wage pressure is easing. KfW Research has raised its inflation forecast for Germany slightly to 2.6% for 2024 (+0.1 percentage points). Next year, the increase in consumer prices is likely to sit at 2.2% (+0.2 PP) and further converge on the ECB’s 2% target.

Even if the German economy is likely to return to growth this year, some structural challenges remain. Transitioning the economy and society to carbon neutrality will likely be the greatest of these challenges in the medium to long term. According to the Ecological Price Tag for GDP introduced by KfW Research, our current economic forecast implies that greenhouse gas (GHG) emissions will continue to fall. The annual caps on GHG emissions that were newly introduced for the current decade under the amendment to the Federal Climate Change Act will presumably be complied with in 2024 and 2025. Nonetheless, it remains a matter of urgency to act on climate change to meet the GHG reduction target of 65% by 2030 as well, and the long-term goal of climate neutrality by 2045, particularly in buildings and transport.

In the euro area, the economic weakness of the second half of 2023 also appears to have been overcome. After the euro area economy contracted by a scant 0.1% in the final quarter of 2023, (price and seasonally adjusted) growth of 0.3% on the previous quarter was a positive surprise in the first quarter of 2024. For all of 2024, KfW Research now expects real growth of 0.8% (previous forecast: +0.6%) and an inflation rate of 2.4%. We still expect GDP growth of 1.5% and an inflation rate of 2.0% for the euro area for 2025.

Among the forecast uncertainties are the continuing geopolitical and geoeconomic risks, particularly in connection with Russia’s invasion of Ukraine and the Middle East conflict.

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