Germany falls into recession as inflation hits consumers in Europe economy

BERLIN – Germany's economic output in the first three months of the year shrank 0.3 per cent from the previous quarter, the country's statistics office said on Thursday, tipping the economy into a recession.

The result is a setback for Germany, which until now had defied predictions that Russia's full-scale invasion of Ukraine, and the decoupling from Russian fossil fuels that powered the German economy, would send the country into two consecutive quarters of negative growth, the common definition of a recession.

But the economy weakened in late 2022, contracting 0.5 per cent. This year, stubbornly high inflation caused consumers to scale back consumption, sending spending down 1.2 per cent in the first three months of the year.

Why it matters

Germany is Europe's largest economy and its health directly affects the health of the 20-member eurozone and the wider European Union, the world's third-largest economy, after the United States and China, in terms of output and purchasing power, according to the World bank.

Initial estimates predicted that the German economy would remain flat in the first quarter, but the update on Thursday fully reflected additional data, including a 3.4 per cent plunge in industrial output in March compared with the previous month, driven by drops in exports and the automotive industry.

Germany's economic growth depends heavily on exports, especially to China, where Volkswagen has been the dominant automaker for years. But a recent surge in the popularity of Chinese-made electric vehicles among customers in Asia caused Volkswagen to report a drop of 15 per cent in sales in China in the first three months of the year.

Overall, exports in March dropped 5.2 per cent from the previous month, according to government statistics.

German industrial companies were forced to scale back production at the end of last year because of energy prices that reached record levels, driven up by Germany's need to buy more liquefied natural gas, or LNG, which is more expensive than the Russian gas delivered by pipeline.

Inflation and high interest rates

Inflation remains high in Germany, at 7.6 per cent in April, and the European Central Bank has indicated that it may continue to raise interest rates to help bring the rate of price gains closer to its 2 per cent target.

At the same time, unions have been battling employers for higher wages to keep up with rising prices. Settlements reached in key sectors, including industrial and service workers, helped to drive wage increases up 6.3 per cent in the first three months of 2023.

Still, economists stressed how hard those with the lowest incomes in Germany were being hit by the price spiral.

“In many cases, people with low wages and incomes will need at least another five years before the purchasing power of their wages, and thus their standard of living, will return to precrisis levels,” said Marcel Fratzscher, president of the German Institute for Economic Research.