Germany teetering on edge of recession that risks dragging rest of Europe down with it

Germany is teetering on the edge of a recession after fresh figures out today revealed its economy unexpectedly contracted in the final months of last year.

German output dropped 0.2 per cent over the last quarter, below the flatline consensus forecast by investors. 

The shock GDP undershoot raises the risk that the wider eurozone economy could marginally fall into a technical slump, defined as  two consecutive quarters of contraction, despite experts recently scrapping their recession forecasts for the common currency area.

If the eurozone or German economies do tip into recession, it would mean the UK is not the only major economy to undergo a slump this year, as experts such as Goldman Sachs have been warning.

GDP grew 0.4 per cent in the third quarter, meaning Germany has not yet reached technical recession definition, but will if output shrinks again in the current quarter, which analysts said is a real possibility.

The “balance is now, again, tilting towards the idea that Germany is in a technical recession, despite green shoots in the surveys and robust hard data through November,” Claus Vistesen, chief eurozone economist at consultancy Pantheon Macroeconomics, said.

A gas crisis in Europe sparked by Russia sucking supplies out of the continent in retaliation to sanctions levied on it in response to its invasion of Ukraine led economists to warn the bloc will suffer a sharp recession this year.

Those projections, however, have been ditched due to a warmer than feared winter curbing energy demand and strong inflows of liquified natural gas replacing Kremlin supplies quickly.

For years Germany has relied on cheap Russian energy to power its manufacturing industry, which generates a big chunk of GDP.

With Europe’s largest economy now flirting again with a recession, the risk of wider slump materialising has strengthened. The bloc’s other major countries are not in a recession, but are struggling to squeeze out meaningful growth.

“Looking ahead, we think that [German] GDP will fall again in the first quarter as the inventory correction continues and resilience in manufacturing, mainly due to strength in the auto sector, gives way to weakness,” Vistesen added.

“The fall in German GDP in Q4 shows that the energy crisis started to dent activity at the end of last year. This pours cold water on the recent optimism about the prospects for the euro-zone and suggests that a technical recession in both Germany and the eurozone as a whole is more likely than not after all,” Franziska Palmas, senior Europe economist at consultancy Capital Economics, said.

The European Central Bank (ECB) on Thursday is expected to heap more pressure on the economy with another 50 basis point interest rate hike, sending them to 2.5 per cent, the highest level in many years.

ECB president Christine Lagarde and co have signalled they still have a long way to go. Analysts at investment bank Nomura think European interest rates will peak at around 3.5 per cent.

Other central banks, including the Bank of England and US Federal Reserve, are also anticipated to lift rates this week, although investors think they are nearing the end of their respective tightening cycles.