Germany’s Divergent Sectors: Capitalizing on Manufacturing Resilience Amid Services Weakness

Germany’s economy is navigating a stark divergence between its services and manufacturing sectors, creating both challenges and opportunities for investors. While the services sector, which accounts for nearly 70% of GDP, has shown signs of stagnation, the manufacturing industry is exhibiting cautious optimism amid structural reforms and fiscal stimulus. This divergence demands a nuanced approach to sector rotation and macroeconomic positioning, balancing exposure to resilient industrial segments with caution in services-driven assets.

Manufacturing’s Fragile Stabilization

The manufacturing sector, long the backbone of Germany’s export-led economy, has shown tentative signs of recovery. In August 2025, the HCOB Germany Manufacturing PMI rose to 49.9—a 38-month high—driven by robust new orders and export growth [3]. This marks a critical inflection point, as the index edges closer to the 50.0 threshold that separates contraction from expansion. Output growth hit a 41-month high (52.6), supported by a surge in new orders—the fastest growth since March 2022 [3]. Export sales, a lifeline for German manufacturers, extended their growth streak to four months, partially offsetting domestic demand weakness [3].

However, challenges persist. Employment in manufacturing continues to decline, and business sentiment remains subdued. The strong euro and falling oil prices have eased input cost pressures, allowing firms to pass on savings to consumers [3]. Yet, the sector remains vulnerable to U.S. trade policy shifts, which have already reduced GDP growth by 0.1 percentage points in 2025 [1].

Services Sector Stagnation

In contrast, the services sector has shown a more pronounced slowdown. The HCOB Germany Services PMI dipped to 50.1 in August 2025, a slight decline from July’s 50.6 but still above market expectations [1]. This near-stagnant growth reflects a minor decline in new business intakes after a brief rebound. While business confidence remains slightly above historical trends—driven by optimism about lower interest rates and government stimulus—the sector’s expansion is losing momentum [1].

This pattern mirrors the 2015 divergence, where services growth cushioned the economy during manufacturing slumps [2]. However, the current environment is more complex. Core inflation in services remains elevated at 2.6%, driven by strong wage growth, while headline inflation is projected to fall to 2.1% in 2025 due to energy price declines [2].

Macroeconomic Positioning: Fiscal Stimulus and Monetary Policy

Germany’s fiscal strategy is shifting from restraint to expansion. The government plans to increase its deficit from 2.3% of GDP in 2025 to 3.4% in 2026, supported by a €500 billion infrastructure fund and exemptions from the “debt brake” for defense spending [5]. These measures aim to boost growth in energy, transportation, and digitalization, sectors critical to long-term competitiveness.

Monetary policy, however, remains cautious. The European Central Bank (ECB) has cut its deposit rate to 2.5%, signaling a gradual shift toward accommodative policy [5]. Yet, Germany’s fiscal expansion could delay further rate cuts in 2025, as the ECB monitors inflation risks from increased public spending [5].

Sector Rotation Strategies

Investors should prioritize sectors poised to benefit from Germany’s structural reforms and fiscal stimulus:
1. Industrials and Cleantech: The manufacturing sector’s focus on green hydrogen, automation, and infrastructure offers long-term growth. For example, Siemens Healthineers has seen 18% gains in 2025, reflecting demand for healthcare infrastructure [4]. The €9 billion National Hydrogen Strategy aims to establish Germany as a global leader in hydrogen technology [4].
2. Defense and Aerospace: European defense equities surged by 50% in 2025, driven by government-led investments and EU-U.S. tariff protections [1]. Firms like Safran and Liebherr are benefiting from trade stability.
3. Small-Cap Industrial Innovators: These firms, often less exposed to U.S. trade pressures, outperformed large-caps by 4.3 percentage points in 2025, focusing on automation, semiconductors, and renewable energy [1].

Conversely, export-reliant manufacturing segments remain risky due to global demand volatility and trade tensions. Services sectors with high wage-driven inflation, such as business and consumer services, also warrant caution.

Challenges and Risks

Structural issues persist. An aging population, labor shortages, and administrative inefficiencies could limit the effectiveness of fiscal stimulus [2]. Additionally, U.S. tariffs on EU imports are projected to reduce GDP growth by 0.3 percentage points in 2026 [1]. Investors must also monitor the ECB’s response to inflationary pressures from increased public spending.

Conclusion

Germany’s divergent sectors present a compelling case for strategic sector rotation. While the services sector provides a buffer against broader economic weakness, manufacturing’s stabilization—driven by fiscal stimulus and export resilience—offers a foundation for long-term growth. Investors should overweight industrials, cleantech, and defense while maintaining a cautious stance in services and export-heavy manufacturing. As the ECB navigates the balance between inflation control and growth support, positioning for Germany’s re-industrialization and green transition will be key to capitalizing on this unique economic landscape.

Source:
[1] ifo Economic Forecast Summer 2025: Recovery Is Getting ..., [https://www.ifo.de/en/facts/2025-06-12/ifo-economic-forecast-summer-2025]
[2] OECD Economic Outlook, Volume 2025 Issue 1: Germany, [https://www.oecd.org/en/publications/2025/06/oecd-economic-outlook-volume-2025-issue-1_1fd979a8/full-report/germany_39d4231a.html]
[3] German Manufacturing Resilience: A Strategic Play in ..., [https://www.ainvest.com/news/german-manufacturing-resilience-strategic-play-european-equities-fx-markets-2508]
[4] 5 High-Growth Sectors for Foreign Investors in 2025, [https://www.sandsconsult.com/knowledge/germany-growth-sectors-foreign-business]
[5] What Germany's fiscal shakeup means for markets - Vanguard, [https://corporate.vanguard.com/content/corporatesite/us/en/corp/vemo/what-germany-fiscal-shakeup-means-markets.html]