The energy shock is further slowing economic growth and fuelling prices. The DIW institute has halved its growth forecast. Fiscal expansion may soften inflation but cannot fully offset it.
Germany's economic recovery is turning out weaker than expected in the spring. That is the conclusion reached by experts at the German Institute for Economic Research (DIW). They have halved their growth forecast for the current year to 0.5 percent.
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'The energy price shock is clearly slowing the recovery,' says DIW chief economist Geraldine Dany-Knedlik. However, she stresses that the situation is not a repeat of 2022/23. That was the year Russia launched its full-scale invasion of Ukraine. 'The shock is smaller, energy supplies are still secure, and Germany is now less dependent on fossil fuel imports than it was after the start of the war in Ukraine,' Dany-Knedlik explains.
'The only reason the economy is growing at all this year is public spending,' the chief economist makes clear. Household demand is weakening and companies have recently become more cautious. Rising government expenditure, for example through higher defence spending and the special fund, is instead propping up economic growth.
The government had already revised down its growth forecast in its spring projections. Having initially assumed growth of 1.0 percent, by the end of April it was only expecting 0.5 percent. That is in line with the estimate from the Kiel Institute for the World Economy (IfW). The federal government does, however, explicitly state that private consumption remains a pillar of the economy. Public investment, meanwhile, is providing important impetus for growth.
Stability through defence spending
Rising defence expenditure and, with a time lag, funds from the special budget for infrastructure and climate neutrality are shoring up the German economy and ensuring modest growth in both forecast years, the DIW argues in a recent press release.
'However, these fiscal policy impulses do not fully offset the cyclical downturn,' Dany-Knedlik adds. 'What matters is that the resources from the special funds are disbursed quickly and genuinely on top of existing budgets, rather than merely financing investments that were planned anyway.'
The DIW describes other problems facing the German economy as 'structural'. Industry is no longer as competitive as it once was, with the automotive sector in particular under pressure. High production costs and demographic change are also weighing on competitiveness. According to the institute, these factors are limiting growth potential and making a rapid cyclical recovery more difficult – regardless of the current geopolitical situation.
US as energy producer the winner, euro area the loser
Internationally, the DIW forecasts that, as a major energy producer, the United States will continue to post relatively solid growth rates of just over 2 percent, while the outlook for the euro area is significantly weaker.
The US has meanwhile become one of the world's largest exporters of liquefied natural gas (LNG) and is benefiting in part from higher gas prices, whereas Europe has to import its energy. Once Russian gas supplies were cut off, the first port of call for new deliveries was overseas.
Europe does not produce enough energy itself and is therefore dependent on imports. Any price shocks associated with this weigh on the economy and erode purchasing power. The DIW does not expect a supply shock, arguing that security of supply for oil and gas is not at risk, particularly thanks to a diversified set-up.
But highly energy-intensive sectors such as chemicals, steel and paper are suffering from rising electricity and gas prices. On DIW assumptions, this means Germany is being hit harder than other European countries.
Expansionary fiscal policy cushions inflation, but does not fully absorb it
As the shock is dampening growth while pushing up prices at the same time, Dany-Knedlik describes it as an 'uncomfortable situation'. So far, expansionary fiscal policy has been able to cushion the higher inflation in particular. But it is not delivering the desired growth.
Consumers are also feeling the impact of higher energy costs in their daily lives, for heating, electricity and transport. That leaves less money for private consumption, as the ifo Institute notes in its Joint Economic Forecast for spring 2026. It remains unclear whether the European Central Bank will respond with an interest rate hike on Thursday.
This is a problem, as the government currently regards consumption as one of the key drivers of growth in the German economy. The DIW takes a more critical view, arguing that growth is due solely to the public sector.
Structural changes in the labour market are also playing a role. Jobs are being cut in manufacturing and retail, while employment in the public sector is steadily increasing. The structural shift towards services is evident, but the overall number of people in work is declining.
Employers, trade unions and the leaders of the governing coalition are meeting at the chancellery today to discuss reforms. The social partners were asked in advance, among other things, to prepare their views on the key factors behind Germany's persistent structural growth weakness.
