German economy slows, inflation rises; fiscal policy supports growth
The Bundesbank's new forecast for Germany indicates that the Middle East conflict is temporarily halting the economic recovery. Bundesbank President Joachim Nagel expects the economy to regain momentum by 2028, supported by falling energy prices, a recovering global economy, and strong fiscal impulses.
Recovery faces headwinds
The Middle East conflict is temporarily stalling Germany's economic recovery, which began in the winter half-year.
Bundesbank President Joachim Nagel expressed confidence, stating that "our forecast period until 2028 sees the economy gaining momentum again.
" The recovery is bolstered by declining energy prices, a strengthening global economy, and robust fiscal policy impulses.
Fiscal measures are preventing an economic downturn in the summer half-year, offsetting the conflict's impact.
However, sharply increased energy prices are dampening household purchasing power and consumption.
Businesses face supply bottlenecks and weaker demand, while high uncertainty and rising interest rates curb private investment.
The Bundesbank forecasts calendar-adjusted real GDP growth of 0.5 percent in 2026 and 0.8 percent in 2027, accelerating to 1.4 percent in 2028.
Nagel noted that "overall economic capacities are gradually being better utilized again.
" Structural impediments like demographic pressure on skilled labor and non-wage labor costs persist, dampening potential growth to merely 0.3 to 0.4 percent annually.
Inflationary pressures persist
Inflation risks have increased due to the Middle East conflict.
Bundesbank President Nagel noted, "The energy price shock drives inflation upwards.
" The Harmonised Index of Consumer Prices (HICP) is projected to rise to 2.9 percent in 2026, only slightly declining to 2.7 percent in 2027.
This persistence is attributed to the delayed pass-through of higher energy prices into living costs, affecting both headline and core inflation.
A significant drop to 1.9 percent is expected only in 2028, partly due to the shift to the European Emissions Trading System (ETS II).
However, core inflation remains relatively high at 2.3 percent in 2028, driven by economic recovery and stronger unit labor cost growth.
Uncertainty looms large
The Bundesbank's forecast highlights a delicate balance where expansive fiscal policy props up growth but at a rising cost to public finances.
While the economy is set to regain momentum, persistent core inflation and structural impediments pose long-term challenges.
The geopolitical situation adds significant uncertainty, making the path to stable growth and price stability precarious.