Germany enters recession: What went wrong with Europe's largest economy?

Germany's economy, the world's fourth-largest, shrank marginally in the first quarter of 2023 compared to the previous three months, thereby entering a technical recession, data showed on Thursday.

According to preliminary estimates, Germany's gross domestic product (GDP) remained stagnant at zero growth in the first quarter, narrowly avoiding a recession. However, recession fears were reignited earlier this month when statistics indicated that German industrial production declined more than expected in March, hampered by a disappointing performance in the key automobile industry.

Why it matters

Germany is the first big country to officially enter a recession since the Covid-19 pandemic. It is the product of excruciatingly high inflation and the most aggressive monetary tightening cycle in decades.

By the numbers

According to Germany's statistics agency, the economy contracted by 0.3 per cent in the first quarter of the year, following a 0.5 per cent contraction in the final three months of 2022.

The first-quarter result was revised lower from the initial flat reading, giving the appearance that Germany had (just) narrowly avoided a recession.

Flashback

Germany's economy depended on a steady supply of Russian natural gas, which was cut off following Russia's invasion of Ukraine. Energy prices have skyrocketed, causing major problems for both businesses and households.

A mild winter ensured that those worst-case scenarios were avoided. Nonetheless, "the warm winter weather, a rebound in industrial activity, helped by the Chinese reopening, and an easing of supply chain frictions, were not enough to get the economy out of the recessionary danger zone," Carsten Brzeski, an economist at ING, wrote in a note on Thursday morning.

Between the lines

Germany may be more exposed to the Ukraine conflict than most big economies, but it is not a large anomaly.

The economy of the UK appears to be quite poor, while the US experienced back-to-back quarters of negative growth in early 2022.

What they're saying

The government stated that "the persistence of high price increases continued to be a burden on the German economy at the start of the year." 

Last quarter, household consumption declined 1.2 per cent, owing to lower purchases of food, clothing, and new cars.

Germany's annual inflation rate was 7.6 per cent in April, down from a peak of 11.3 per cent last year. However, core inflation, which excludes food and energy, has not been declining, indicating a broadening of pricing pressures.

The bigger picture

The European Central Bank has clarified that its efforts to reduce inflation are far from over. Further interest rate hikes are almost certain, and they will likely slow the eurozone economy even more.

The bottom line

"[T]he optimism at the start of the year seems to have given way to more of a sense of reality," Brzeski said.

"A drop in purchasing power, thinned-out industrial order books as well as the impact of the most aggressive monetary policy tightening in decades, and the expected slowdown of the US economy all argue in favour of weak economic activity."