How close is Germany to recession?

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A growing body of economic data suggests that Germany may well be headed for an economic downturn. That should get worse – depending on how hard the winter gets.

For the fifth time in a row, German industry received fewer orders than in the previous month. In June, orders fell by 0.4 percent compared to May. What looks like little at first glance adds up to a minus of 5.6 percent in the second quarter.  Even if the current order backlog is still very high – also because of the ongoing problems in the supply chains – it shouldn't prevent the economic problems from affecting industrial production, says Jörg Krämer, chief economist at Commerzbank: “The risk of a recession increases.”

Other economists think so too. Dekabank, for example, is also expecting a technical recession – i.e. a contraction of the economy in two consecutive quarters. “But it could also be that the recession stretches from the fourth quarter of this year into the second quarter of next year,” says their economic expert Andreas Scheuerle. However, the decline in orders is only one indication of the difficult economic situation. There are several reasons for the economic weakness.

Inflation eats up purchasing power

On the one hand, there is high inflation, which is weakening the purchasing power of consumers: “People can no longer afford as much and perhaps no longer want it,” says Scheuerle. Because there is great uncertainty as to what costs they could still face, for example from the rising energy prices caused by the war and the gas levy. The consumer climate index of the  Nürnberger GfK at the end of July, when the mood barometer continued to plummet.

Production line at chainsaw manufacturer Stihl

On the other hand, the world economy is weakened, especially the USA, one of the most important sales markets for German industry. Because inflation is so high there, the American Federal Reserve is tightening the reins much faster and more strongly than the ECB is doing in the euro area. And thirdly, the uncertainty about the gas supply is also weighing on companies. “There will probably not be heavy rationing in winter,” suspects Dekabank economist Scheuerle. But companies are likely to economize on gas consumption, producing less than what would be possible under normal conditions.

And last but not least, nobody currently knows how much the corona virus will spread again in winter. This would affect the economy above all through higher sick leave. Scheuerle believes that there should probably no longer be lockdowns in Germany. But: “You always have to expect that another location or port in China will temporarily close.” The effects this has on the supply chains could be seen in the spring.

Fear of the gas crisis is paralyzing companies

Overall, therefore, the confidence of companies is falling. The important Ifo business climate index shows that the demand situation in July deteriorated compared to the previous month. And the business expectations, which the Munich economic researchers also always ask, have fallen sharply for the next six months. That's a level that can be observed during recessions, it reflects “tangible risks,” analyzes Jörg Kramer from Commerzbank: “After all, Putin is playing with the gas tap and fueling the fear of a gas crisis.” He wants to wear the German public down: “This war of nerves over gas is also unsettling companies and making them more cautious when ordering.” In some cases, customers could also cancel or postpone orders. This would gradually use up the high backlog of orders that had actually calmed the industry over the past two years.

So a recession is almost inevitable. but this should not be as sharp and deep as in the financial crisis after the Lehman bankruptcy or in the first months of the corona pandemic. “At its peak, the German economy could shrink by 0.4 percent,” estimates Dekabank economist Scheuerle. But the upswing will not be as strong afterwards either. Because the problem of the gas shortage still exists. In the winter of next year, too, one must reckon with further burdens. And that could then also motivate at least parts of German industry to relocate their production abroad, to where energy is cheaper and local. The current difficulties could therefore lead to long-term structural changes in the economy.