Europe’s economic engine is sputtering yet again, and the outlook is getting worse with every day that the conflict in the Middle East drags on.
The German government cut its growth forecast for this year and next on Wednesday, squarely blaming the U.S.-Israeli war on Iran.
The conservative-led coalition of Chancellor Friedrich Merz now expects the economy to grow only 0.5 percent this year, down from a prior estimate of 1.0 percent. For 2027, it likewise trimmed its forecast to 0.9 percent from 1.3 percent.
“Economic developments in Germany will depend crucially on a resolution of the conflict in the Middle East,” the German economy ministry said in a regular update of its forecasts. “Even then, however, high energy prices, supply disruptions and economic strains are likely to persist for some time.”
While President Donald Trump did on Tuesday extend the shaky ceasefire that’s been in place between the U.S. and Iran for two weeks, that has so far not been enough to restore the smooth flow of oil, gas and other essential commodities for the world economy in and out of the Persian Gulf.
The war has once again undermined confidence in the ability of Europe’s largest economy to pull itself out of a four-year funk, which has been caused by the loss of cheap Russian energy, intensifying competition from China and an accelerating exodus of older workers from the labor force.
The latest disruptions threaten to kill off a budding recovery that has been encouraged by a sharp rise in government spending. Even as independent analysts questioned the effectiveness of Merz’s spending splurge—arguing too little was earmarked for growth-boosting investment—most still expected it to deliver a short-term bump.
The German government’s downgrade was no surprise after the International Monetary Fund and leading domestic research institutes cut their forecasts in recent weeks.
The Deutsche Bundesbank, Germany’s central bank, is no less gloomy. While it said earlier on Wednesday that it expects growth to stay positive in the current quarter, “it is to be expected at the same time that the effects of the war in the Middle East will have a broader and more noticeable impact.” The Bundesbank cited “increased energy prices, supply chain problems, increased uncertainty, increased interest rates and deteriorating export prospects.”
Inflation to rebound
Rising energy prices will likely push inflation back toward 3 percent this year and next, the government said — prompting financial markets to expect two European Central Bank rate hikes this year.
ECB officials say they won’t overreact to what may be a short-lived blip, but have warned that they will raise rates if they see any signs of inflation taking root again, only four years after the last such shock.
German Economy Minister Katherina Reiche — whose past employment at energy giant E.ON has made her a target for criticism from the left and environmentalists — was quick to blame factors beyond her control for the latest downgrade.
“The recovery that we expected this year will once again be derailed by external geopolitical shocks,” Reiche told a press conference. “The war in Iran is driving energy and commodity prices through the roof. That is hurting households and raising costs for the German economy.”
However, German business and independent economists have both accused the government of failing to do what is in its power to revive growth by undertaking sweeping reforms, including slashing bureaucracy and cutting taxes on energy and labor.
“The cause lies with us,” Peter Leibinger, president of the Federation of German Industries, said earlier this week as the country’s largest business lobby predicted that industrial output would “stagnate, at best” this year. Domestic costs “are simply too high” for Germany to stay competitive, he warned.
Reiche on Wednesday said the government “can’t just ignore” repeated signs of a lack of private-sector confidence. A recent survey from the German Chamber of Trade and Commerce (DIHK) found that while public investment was set to grow 8 percent this year, private-sector investment was likely to stagnate.
Romanus Otte contributed reporting.