Impact of Iran-US-Israel war dampen German economic recovery: ifo

Under the de-escalation scenario, which assumes a quick end to the conflict and only temporary increases in crude oil and natural gas prices, price-adjusted German gross domestic product (GDP) is expected to increase by 0.8 per cent this year and by 1.2 per cent next year. This forecast is thus in line with the ifo Economic Forecast Winter 2025.

Under the escalation scenario, which assumes a much longer conflict with a sharper and more persistent rise in energy prices, the economic burdens will increase noticeably and add up to 0.8 percentage points this year and next year compared to the pre-war scenario.

However, with an increase in price-adjusted GDP gross domestic product of just 0.6 per cent and 0.8 per cent this year and next year respectively, the recovery will continue in the forecast period, albeit at a slower pace.

“Despite the energy price shock, the recovery in Germany is likely to continue in the remainder of this year, particularly because additional government spending on infrastructure, climate neutrality and defense will be expanded and have an increasing impact on demand,” said Timo Wollmershauser, deputy director of the ifo Center for Macroeconomics and Surveys and director of forecasts, in an ifo release.

No immediate energy supply shortage is anticipated now in Germany, as Germany only obtains a small amount of its energy supplies directly from the Arabian Peninsula.

Nevertheless, the impassability of the Strait of Hormuz, the closure of airspace over the conflict region and the mutual attacks on the oil and gas infrastructure are also leaving their mark on the German economy.

First, the global shortage of crude oil and natural gas is causing commodity prices to rise, sharply in some cases. Second, there is a risk that supply chains will be disrupted, particularly between Europe and Asia.

Germany’s export business should also gradually pick up speed again. This is indicated by the improvements in the ifo export expectations and export climate indices in recent months.

The US import tariffs continue to weigh on German exports to the United States. This will probably not change following the US Supreme Court’s ruling in February, which altered the effective tariff burden for the world and Germany only to an insignificant extent, ifo noted.

Nevertheless, adaptations to the new conditions appear to have been largely completed. At any rate, exports to the United States did not fall any further at the end of the year.

A similar picture is also emerging for exports to China. Their decline since 2021 came to a halt last year.

Finally, exports to the European Union, by far the most important sales market for German companies, have already gained momentum over the course of the past year.

The energy price shock will put a damper on this recovery, but will not bring it to a standstill.

In the de-escalation scenario, the rise in energy prices in the coming months will cause a short-term increase in the inflation rate to just under 2.5 per cent. This will reduce the purchasing power of private households and is likely to slightly reduce the expansion of their consumer spending in the first half of 2026 compared to the pre-war scenario.

As the most important sales markets for German companies are similarly affected by the energy price shock, the expected recovery in export business and private investment activity will be somewhat weaker.

In the escalation scenario, the inflation rate remains higher for longer and peaks at just under 3 per cent. This is due not only to the stronger rise in energy prices in this scenario, but also to the fact that higher production costs will be passed on to the prices of other goods and services.

Overall, the energy price shock in the escalation scenario will have a greater dampening effect than in the de-escalation scenario.

The economic recovery will reach the labour market with a slight delay. In all scenarios, the unemployment rate will be lower next year than this year.

However, while registered unemployment will already have peaked in the first quarter of 2026 in the pre-war scenario, the turning point in the de-escalation scenario is pushed back to the summer and, in the escalation scenario, to the fall of the current year.

The number of people in employment will also fall again this year and will only increase next year as the recovery progresses. The extent of the changes will vary depending on the respective scenario, ifo added.

Fibre2Fashion News Desk (DS)