ifo Economic Forecast Spring 2023: German Economy Stagnating

Forecast for the German Economy

The peak of the inflation wave has probably been reached by now. In particular, energy prices are not expected to provide any further impetus over the coming months. Wholesale prices for electricity and gas have fallen noticeably since late summer last year and government price brakes have been in place since January. For the time being, this is providing relief above all for companies whose energy costs are determined by market prices. According to the ifo Business Survey,  manufacturers are consequently planning noticeably fewer price increases in the coming months, so the rise in producer prices is likely to slow further. However, a noticeable decline in consumer price increases will be some time coming, as municipal energy suppliers will pass on the lower procurement costs to their customers only after a delay. This means that for private households, energy prices will not fall below their prior-year level until the end of 2023 at the earliest. The same applies to businesses in consumer-related areas of the economy, which also purchase most of their energy from municipal suppliers. Price pressure from labor costs will increase, as noticeable rises in collectively agreed wages are expected in the course of this year.

Overall, therefore, the core inflation rate in particular (i.e., the increase in consumer prices excluding energy) is likely to decline only slowly over the further course of the year and, at an annual average of 6.3% in 2023, may even be significantly higher than in the previous year (4.9%). However, as the inflation contribution from energy prices declines sharply in the coming months, the overall inflation rate is likely to fall from 6.9% in 2022 to 6.2% in 2023. Only in the coming year should price increases gradually return to normal. Assuming that commodities and energy do not become significantly more expensive over the forecast period in line with current market expectations and that the European Central Bank continues to raise its key interest rates, the inflation rate should fall to 2.2% and the core rate to 2.8% in 2024.

In the further course of the year, the economy will recover in almost all industries. This is indicated by the noticeable improvement in ifo business expectations since October 2022. Orders in manufacturing have been increasing again since the beginning of the year, and the global economy is expected to gain momentum. Slowly falling inflation rates and rising wages should lead to real wage growth again from mid-year at the latest and support the domestic economy. By contrast, the construction industry is likely to be a drag, even though surprisingly high production growth was recorded there at the beginning of the year. Demand for construction services has slumped sharply, not least as a result of rapidly rising financing costs.

Key Forecast Figures for Germany

Source: Federal Statistical Office; Federal Employment Agency; Deutsche Bundesbank; 2023 to 2024: forecast by the ifo Institute.
© ifo Institute Mar. 2023

All in all, price-adjusted GDP will stagnate this year at roughly the same level as last year (−0.1%) and increase by 1.7% next year. The economic weakness will slow employment growth somewhat this year. As early as next year, the unemployment rate is expected to fall again to 5.1%, after standing at 5.4% this year and 5.3% last year.

The government budget will remain in the red this year and next year, at 1.3% and 0.3% of economic output respectively. However, the government financing deficit is significantly lower than expected in the ifo Economic Forecast for Winter 2022. In particular, the expenditure budgeted for the government’s energy price brakes has been reduced by a good EUR 35 billion in total, because from today’s perspective the wholesale prices for electricity and gas in the forecast period are significantly more favorable than they were three months ago. The current account balance will rise again to 5.9% of economic output by 2024, after falling temporarily to 3.8% last year as a result of the sharp rise in import prices.

Risks to the Forecast

The risks to this forecast are manifold. In the short term, manufacturing could recover more strongly if supply-side bottlenecks ease more quickly than expected. Manufacturing companies’ order backlog remains considerable, and in the meantime new orders are also picking up again. In addition, there is enormous catch-up potential in the energy-intensive sectors, where output at the end of 2022 was 17% lower than a year earlier. The sharp rise in industrial production in January 2023 was largely due to these sectors benefiting from falling gas and electricity prices.

By contrast, high inflation could dampen the domestic economy more than assumed in this forecast. Above all, it is unclear how private households will react to the high price increases and the associated liquidity squeeze. It is quite conceivable that they will increase their propensity to save and set aside an increasing share of their income, possibly as a precautionary measure. This would have a greater impact on private consumption. Domestic price dynamics could also weaken more slowly than expected, for instance because collectively agreed wage increases or profit expansions turn out to be higher. This would delay the decline in the core inflation rate and require a more restrictive monetary policy response. Construction activity in particular is likely to be hit even harder as a result.