La Française: How to get Germany out of the rut

December 20, 2024

At best, German economic growth is expected to be flat in 2024; current economic consensus forecasts show a 0.6% increase in 2025. While this is an improvement, it remains disappointingly weak.

Recently, the Bundesbank drastically revised its forecasts downward, now forecasting growth of just 0.2% for 2025 (compared to the previous estimate of 1.1%). We are no more optimistic than the Bundesbank.

The issues remain the same and stem from the political choices made by the German government in recent years.

• Germany currently relies on its capacity to generate renewable energy at competitive prices while ensuring consistent availability. However, the past couple of weeks have demonstrated how challenging this is, especially when the number of hours of sunlight and wind decrease—a phenomenon known as "Dunkelflaute"—which has led to significant spikes in short-term electricity prices. German energy policy has so far been a failure, characterized by unstable production, volatile prices and a continued dependence on coal.
• The broader industrial sector constitutes a significant portion of the German economy (20% of added value and over 16% of jobs, Source: Direction Genérale du Tresor, data as at 31/12/2023), and a meaningful rebound is unrealistic as long as Germany is unable to supply energy to its industries at competitive prices.
• The consequences of high energy prices extend beyond the industrial sector. Food prices, linked to the cost of gas (which is essential for fertilizers), have also risen sharply. As a result, German consumers face high prices for non-substitutable goods, i.e., energy and food, which disproportionately affect the less affluent segments of the population. This erodes disposable savings and consumer confidence, logically leading to stagnant consumption in Germany. This trend is also evident in other European countries, e.g., France.

The chart below illustrates how the situation has evolved differently in Germany versus Spain, highlighting why the German economy is stagnating while Spain's economy has a positive dynamic. The Bank of Spain has even revised its 2025 growth forecast upward from 2.2% to 2.5%, with growth in 2024 expected to be around 3%. Other explanatory factors exist (Next Generation EU, tourism in Spain, fiscal stimulus measures, etc.), but the differential in access to low-cost energy remains, in our view, the primary factor.

As a reminder, electricity prices in European markets are set by marginal costs (the cost of producing one more MWH of electricity). The weak interconnections between Spain and Portugal, on the one hand, and the rest of the European market, on the other, explain the implementation of the “Iberian exception” and why energy prices are significantly lower in Spain and Portugal today.

As long as Germany's energy issues remain unresolved, it will likely be difficult to see a meaningful rebound in the German economy. However, there are some reasons for hope. A recovery in the Chinese economy would be good news for German exports, but this is not our baseline scenario—stabilization seems more likely. German elections early next year could lead to increased fiscal stimulus. Achieving political consensus on this issue will be challenging given the two-thirds majority required to amend the constitution. Fiscal stimulus may be necessary to counter potential measures from a Trump administration targeting Germany’s substantial trade surplus with the United States.