Europe’s largest economy has been in a recession for 6 months and nobody noticed

May 26, 2023, 3:15 PM UTC
German Economy Minister Robert Habeck failed to prevent the country from sliding into a recession over the winter.
German Economy Minister Robert Habeck has more work to do, as the country slid into a recession over the winter.
Florian Gaertner—Photothek/Getty Images

Anyone looking for proof that financial markets do not necessarily reflect the real economy need look no further than Germany. Less than a week after the country’s blue-chip index notched a new record closing high, federal statisticians reported on Thursday that Europe’s largest economy is mired in a recession. The downward revisions to earlier estimates now reveal total output contracted in two straight quarters—by 0.5% at the end of last year and 0.3% at the beginning of this one—fulfilling the criteria for a technical recession.

Initially, official estimates suggested a decline of 0.2% and stagnation, respectively.

So, what is going on here?

The root cause for the country’s ills is shrinking consumer spending over the winter exacerbated by higher energy costs from the abrupt shift away from reliance on cheap Russian oil and gas. 

Domestic consumers typically must save a much higher portion of their income owing to a comparably low rate of home ownership and the lack of a widespread equity culture.

Yet the 1.2% Q1 decline proved worse than anticipated as 9%-plus annualized inflation rates ate into their disposable income.

The arrival of warmer temperatures and lower heating bills points to short-term relief, but a combination of factors suggests Europe’s once dynamic economic engine will ultimately stall as higher interest rates cool off activity in capital-intensive industries like manufacturing and construction. 

The Macroeconomic Policy Institute in Düsseldorf predicts only “lukewarm growth” in the upcoming summer months: “Unlike in other phases of expansion, the recovery in China is not being supported through robust investments from which the German export economy can profit.”

Recovery already underway

The chief economist at Hamburg Commercial Bank, which copublishes a purchasing managers index for Germany together with S&P Global, believes the recession has already ended thanks to a recovery sparked by the service sector. 

“There are still signs of pent-up demand here following [COVID], whether it’s for traveling or eating out at a restaurant,” Cyrus de la Rubia told Fortune.

Moreover, the financial sector is not about to throttle the supply of credit to the real economy, as is widely feared in the United States following the collapse of three major regional banks. 

“Lending conditions are certainly tightening, but not excessively in a historical context, and certainly not to the extent that one should fear a credit crunch,” de la Rubia said.  

Nevertheless, higher borrowing costs and weak export prospects for China mean he is expecting only tepid growth of 0.2% for the full year. 

The fact that Germany’s 40 blue chips comprising the DAX closed at a new record high on Friday amid such challenging economic conditions is in part due to one important aspect that differentiates it, de la Rubia explained.

“It’s a so-called performance index based on total shareholder returns. That means the automatic reinvestment of dividends is incorporated into its calculation,” he said. “If you look at the ‘price index’ adjusted for this effect that’s comparable to the S&P 500, you’ll see that it’s still markedly below its all-time high.”

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