ifo Economic Forecast Summer 2023: Inflation Slowly Easing – But Economy Still Faltering in Germany

Germany’s economy suffered a sharp setback in the winter half-year. As a result of high inflation, demand weakened noticeably. Gross domestic product will decline by 0.4% this year and increase by 1.5% next year. The inflation rate is expected to fall from 6.9% in 2022 to 5.8% in 2023 and 2.1% in 2024.

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Different Forces Shape Economic Development

High inflation in consumer prices will again reduce the real incomes of private households and thus consumption in the spring. It is only from the second half of the year that incomes are expected to rise more strongly than prices and private consumption to pick up. Construction activity will cool throughout the forecast period. The rise in construction prices is only declining slowly and interest rates on loans will remain high, further subduing demand for construction services. Thanks to high order backlogs, manufacturing is expected to continue to expand its output moderately and then grow significantly more strongly again as supply bottlenecks gradually disappear. The situation in the energy-intensive branches of production within German manufacturing is likely to remain fraught, preventing an even stronger expansion of gross value added. All this is based on the assumption that there will be no gas shortage in the coming winter. All in all, gross domestic product will decline by 0.4% this year and increase by 1.5% next year.

Price Pressure Slowly Easing

Inflation rates are expected to fall further in the coming months. There are now signs of price decreases for intermediate input costs – in particular energy – that producers will pass on to their customers. However, wage growth is likely to accelerate for the rest of the year as more inflation bonuses are being paid out and noticeable increases in collectively agreed wages are taking effect. The overall inflation rate is expected to fall from 6.9% in 2022 to 5.8% in 2023. It won’t be until next year that price increases will gradually return to normal and the inflation rate will fall to 2.1%.

“The German economy is only very slowly working its way out of the recession.”

Prof. Dr. Timo Wollmershäuser, Deputy Director of the ifo Center for Macroeconomics and Surveys and Head of Forecasts

Subdued Momentum in the Labor Market

The economic slowdown will also leave its mark on the labor market. Employment growth is likely to weaken noticeably in the coming months. For the remainder of the forecast period, demographic developments in particular will prevent employment growth from accelerating substantially. Despite immigration and the ongoing integration of Ukrainian refugees into the labor market, Germany’s labor force is expected to peak in the coming year due to aging. Overall, the increase in employment is expected to slow from about 592,000 in 2022 to 377,000 in 2023 and 121,000 in 2024, while unemployment is expected to rise by 132,000 this year and fall again by 104,000 next year. As a result, the unemployment rate in 2023 and 2024 is 5.5% and 5.3%, respectively, up from 5.3% last year.

Government Deficit Slowly Declining

Fiscal policy is once again expansionary this year. This is mainly due to the relief provided under the Inflation Adjustment Act and spending in connection with the gas and electricity price brakes. Most of these measures will expire next year and fiscal policy is then likely to shift to a restrictive course. The government’s deficit will decrease from EUR 69 billion, or 1.7% of nominal GDP, this year to EUR 27 billion, or 0.6% of nominal GDP, next year. Gross debt according to the Maastricht criteria will then fall to 62.7% of nominal GDP in 2024.

More Restrictive Monetary Policy Increasingly Taking Effect

In the forecast period, monetary policy is likely to remain restrictive, even though the end of the cycle of interest rate hikes is in sight. At the July meeting of the ECB Governing Council, key interest rates are expected to rise by a further 25 basis points. They are likely to remain at this level for some time before starting to fall again slightly in the summer of 2024 as inflation momentum slows. This “wait-and-see” approach seems appropriate because there is a high degree of uncertainty about the speed and effectiveness of monetary policy transmission. In line with the monetary policy stance, financing conditions will remain tight for the time being. As a result, the current yield on ten-year German government bonds is expected to rise slightly to 2.8% and remain roughly at this level.

Key Forecast Figures for Germany

Table ifo Economic Forecast Summer 2023: Key Forecast FIgures for Germany

Chart ifo Economic Forecast Summer 2023: Gross Domestic Product in Germany

Euro Area and Global Economy

Following the slight decline in GDP in the winter half-year, the euro area’s economy is unlikely to pick up in the coming quarters. For 2023 as a whole, gross domestic product is expected to increase by only 0.6%. Member states with a higher share of services will likely perform slightly better than the average. In the coming year, the global economy is expected to give renewed impetus to industry in the euro area and accelerate growth to 1.3%.

In May, the decline in inflation continued in the euro area, following a brief pause in April. The energy sources included in the consumer price index have not played a role in the rise in inflation since March this year. In the coming months, their price decline should further reduce inflation. In 2023, consumer prices are expected to rise by 5.4%, compared with 8.4% in the previous year. In 2024, they may even fall to 2.0%.

In the USA, consumer surveys have shown a decline in household confidence since the beginning of the year. This trend continued until May 2023. Economic surveys among US industrial companies have also pointed to an impending recession for some time. Overall, the US economy is expected to expand by 0.9% in the current year. Despite a revival of economic momentum in the coming year, growth in 2024 is expected to be only modest at 0.6%.

The pent-up consumption demand resulting from the coronavirus crisis will favor the expansion of domestic demand in China this year and next. Despite a strong start, economic growth is likely to slow as the year progresses, since the subdued economic environment in the USA and Europe is weighing on Chinese exports. In May 2023, for example, goods exports fell by 7.5% year-on-year. The economy is not expected to pick up again until the end of the year. Overall, price-adjusted GDP is expected to grow by 5.6% in 2023 and by 4.6% in 2024.

On the whole, the world’s gross domestic product will expand by 2.1% in 2023 and by 2.0% in 2024, following an increase of 2.8% last year. World trade will grow again by 2.7% in 2024, following a decline of 2.0% this year. Consumer price inflation in the global economy will slow from 7.1% last year to 4.5% this year and 2.8% next year.