German economy to contract as energy crisis hits consumers, warn analysts

Germany’s economy will shrink next year as soaring energy costs caused by Russia’s throttling of gas supplies reduce disposable income and consumers rein in their spending, according to a leading think-tank.

The Ifo think-tank in Munich warned that the recent surge in electricity and gas prices was “wreaking havoc” on the German economy and would lead to a 0.3 per cent decline in gross domestic product next year — a marked deterioration from an estimate of 3.7 per cent growth, made in June.

The main cause was the expected “decline in private consumer spending” triggered by energy suppliers “markedly adjusting their electricity and gas prices in the light of high procurement costs, especially at the beginning of 2023,” said Ifo.

The downgrade underlines the mood of mounting pessimism about the eurozone’s largest economy.

Last week, the Kiel Institute for the World Economy, another think-tank, slashed its forecast for German GDP next year by 4 percentage points to minus 0.7 per cent, warning: “With the high import prices for energy, an economic avalanche is rolling towards Germany.”

German deputy finance minister Florian Toncar on Monday warned of an “increasing risk of stagflation” in the country, telling the VVW insurance sector publication: “We are experiencing supply-chain problems, production bottlenecks and price increases the likes of which we haven’t seen in decades.”

The government in Berlin recently announced a €65bn relief package to cushion the impact of the energy crisis on households, but Ifo said this would “fall far short of offsetting” the blow to household disposable income, which it predicted would drop sharply.

German inflation would average 9.3 per cent next year, up from 8.1 per cent this year, said Ifo, predicting consumer price growth would peak at 11 per cent in the first quarter, which would be a 70-year high.

“The cuts in gas supplies from Russia over the summer and the drastic price increases they triggered are wreaking havoc on the economic recovery following the coronavirus,” said Timo Wollmershäuser, senior economist at Ifo.

Column chart of German GDP (annual % growth) showing recession looms for Germany

Europe’s largest economy, which shrank 4.6 per cent after the pandemic hit in 2020, rebounded last year with growth of 2.9 per cent, according to the World Bank. But in the three months to June, the German economy stagnated.

Carsten Brzeski, head of macro research at Dutch bank ING, said he expected the German economy to start shrinking in the third quarter as high energy prices hit consumers and businesses. “It is like watching a train running into a wall and you can see the wall is coming,” he said.

Some of Germany’s biggest energy users, from steel to chemical companies, are cutting back on production, and business leaders are warning that soaring prices risk eroding the economy’s competitiveness. ArcelorMittal, Europe’s largest steelmaker, said this month it would switch off one of the blast furnaces at a steelworks in Bremen, northern Germany.

However, Ifo sounded relatively upbeat about German industry, predicting that “manufacturing and the associated business services providers will support the economy” and that the sector “will gradually work off the high order backlogs in the coming quarters, slowly expanding its output”.

But it warned that the construction sector was “likely to suffer most directly” from rapidly rising interest rates, which it forecast would hit 4 per cent by the end of the year. Last week, the European Central Bank raised its deposit rate from zero to 0.75 per cent to tackle record inflation in the bloc.

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