German Economy Set to Shrink in 2023, Manufacturing Base Suffers

The German economy is facing a more severe contraction in 2023 than previously anticipated, as the country's manufacturing sector grapples with declining global demand and reduced consumer spending caused by higher interest rates. According to the IfW Kiel Institute for the World Economy, Europe's largest economy is expected to shrink by 0.5% this year, a downgrade from the previous forecast of 0.3% in June.

Weak industrial activity, a crisis in the construction sector, and sluggish consumer spending are cited as the main factors contributing to this downward trend. The organization has also revised its growth expectations for 2024, lowering it to 1.3% from the previous estimation of 1.8%. As a result, the economic output is projected to be approximately 3% below pre-pandemic levels in both 2024 and 2025.

Moritz Schularick, President of the IfW, stated that Germany is now experiencing the repercussions of its outdated industrial business model. Additionally, the economy is being weighed down by the interest rate reversal, which affects both domestic and export markets. Certain segments of energy-intensive production are no longer profitable and unlikely to recover, while exports are suffering due to global investment weakness.

Despite evidence of sound order backlogs supporting German production, recent data from Germany's statistics agency shows a decline in new factory orders in July. The weak demand is expected to persist as key markets like China fail to meet economic momentum expectations.

On a positive note, Germany's labor market is projected to remain strong, while public debt will remain stable, according to the IfW. In terms of inflation, it is anticipated to reach the European Central Bank's target of 2% in 2024 and 2025. However, the core inflation rate—which excludes energy and food prices—will likely remain well above this threshold, further squeezing consumer spending.