Germany's Economy Shrinks by 0.2% in Q4: What's Next for Investors?

The German economy, Europe's largest, has officially entered a recession, with gross domestic product (GDP) contracting by 0.2% in the fourth quarter of 2024, according to the Federal Statistical Office. This follows a 0.1% decline in the previous quarter and marks the second consecutive quarter of negative growth, meeting the technical definition of a recession. The news comes as no surprise, given the headwinds facing the German economy, including high energy costs, significant administrative burdens, growing global protectionist tendencies, and uncertainty surrounding the economic policy direction of the new federal government.



The contraction in GDP was driven by a significant decrease in exports, which fell by 1.6% on a seasonally adjusted quarterly basis. This decline was more pronounced than the 0.8% contraction in Q3. Additionally, public spending growth moderated to 0.3% in Q4, down from 1.1% in Q3. Fixed investment also contracted by 1.9% in Q4, marking the worst reading since Q3 2021.

Looking ahead, the performance of these sectors is expected to evolve as follows:

1. Exports: The German economy could pick up slightly in the first quarter of 2025, with exports potentially developing less unfavourably, particularly if anticipatory effects occur due to looming US tariffs. However, the high economic policy uncertainty and low capacity utilisation are still expected to weigh on investment and domestic demand for capital goods and construction work.
2. Public spending: The government deficit is projected to decrease to 2.0% of GDP in 2025, as stable employment and rising wages, as well as the phase-out of the tax-free bonus to compensate households for high inflation, contribute to a reduction in spending.
3. Fixed investment: Investment in equipment is expected to rebound in 2025, driven by an increase in tax incentives for investment announced in July 2024. Construction is also set to resume growth in early 2025, underpinned by recovering demand for housing and infrastructure, as already signalled by rebounding orders as well as mortgage loans.

These developments suggest that while exports may improve in the coming quarters, public spending and fixed investment are expected to contribute more significantly to economic growth in 2025 and 2026. However, the structural adjustment processes are likely to continue, and the economic brakes will only be gradually released. The tentative recovery is driven by a revival in private consumption, which will be supported by strong growth in real disposable incomes. The upturn in key sales markets, such as neighboring European countries, will support German foreign trade, further benefiting investment in fixed assets.

In conclusion, the German economy's recent performance has been influenced by a combination of cyclical challenges and deep-rooted structural issues. While the current quarter's contraction is concerning, investors should remain optimistic about the long-term prospects of the German economy, given its strong fundamentals and the potential for policy reforms to address the underlying challenges. As always, it is essential to stay informed and adapt investment strategies accordingly to capitalize on the opportunities that arise in the ever-evolving market landscape.