Germany’s economy is facing another uncomfortable situation.
After two decades of relying on exports and industrial might, the model looks tired. Growth has flatlined, the export surplus is shrinking, and even household consumption is struggling to pull the numbers higher.
Some signs are pointing towards a prolonged stagnation, while others are giving hope of a rebound. What’s the most likely scenario?
Why the economy stalled
The data shows a country struggling to grow.
After two consecutive quarters of modest growth, Germany’s GDP shrank by 0.3% in the second quarter of 2025.
Annual growth is now only 0.2%, according to the Federal Statistical Office. Exports fell as US tariffs of 15% on most goods and 27.5% on autos bit into trade, and companies faced weaker demand from China.
Germany’s old advantage, which was its dominance in autos, machinery and chemicals, is now in question.
Volkswagen’s net profit plunged by 36% in the second quarter, underlining how fragile the industry has become.
Chemicals are also being squeezed by high energy costs and Chinese oversupply. Construction remains weak, with residential building only expected to stabilise in 2025.
The Bundesbank has tried to lift the mood, pointing to July industrial production rising 1.3% and arguing that Germany may avoid a technical recession.
But that doesn’t change the trend. The economy has now stagnated since 2019, with output set to remain flat in 2025.
Where the optimism come from
Surveys tell a different story. The Ifo Business Climate Index rose to 89.0 in August, with managers more upbeat about revenues in the next six months. PMI surveys also show modest expansion.
The gap between hard data and sentiment is striking.
Why are firms so confident when the numbers are so weak? Partly because they expect policy to deliver.
Chancellor Friedrich Merz has promised an “autumn of reforms” with tax incentives, pension reform, welfare-to-work changes and a more industry-friendly energy policy.
Brussels has also approved a €500 billion debt-financed programme for infrastructure and defence.
Businesses are counting on these measures to finally move from promise to delivery.
Another reason for optimism is trade. An EU–US deal could soon cut auto tariffs from 27.5% to 15% once Brussels files the right legislation.
German carmakers believe relief is coming, even if a 15% duty is still six times higher than the 2.5% rate they enjoyed before Donald Trump returned to the White House.
At the same time, real wages in the country are rising, giving some optimism to consumers as well. Unions have managed to secure above-inflation pay deals across metalworking and manufacturing.
Some factory workers have seen increases of up to 20% after difficult negotiations, lifting entry-level monthly pay closer to €2,800.
On top of that, Germany’s minimum wage is set to rise to €13.90 in 2026 and €14.60 in 2027, placing it among the highest in Europe.
Why investors shouldn’t celebrate just yet
This optimism gap looks fragile as of now.
Confidence rests on reforms that are not yet detailed and on tariff relief that is not yet in place. Meanwhile, economic weakness will not go away easily.
Energy costs remain far higher than in the US, eroding competitiveness.
The euro has appreciated 13% against the dollar and 11% against the yuan this year, making exports less competitive.
Industrial firms are working below capacity, according to the Bundesbank, which means profit margins are thin and capital spending is likely to stay weak.
The fiscal picture also limits how far Berlin can go. The deficit is projected at 2.7% of GDP in 2025, rising to 2.9% in 2026.
Debt will creep higher to 64.7% of GDP. The government is already debating €30 billion of cuts in the 2027 budget to offset rising spending on infrastructure and defence.
That talk of austerity risks cancelling out today’s stimulus before it even takes hold.
And lastly, the average German citizen doesn’t feel the same optimism as unemployment rises across the board. The number of unemployed people climbed above three million in August for the first time in over a decade, pushing the jobless rate to 6.4% and highlighting the strain on households as labor demand slows and companies cut back.
For investors, this mix means German assets tied to public spending, such as construction, infrastructure suppliers, and defence contractors, look better placed than industries exposed to US trade tensions.
Autos remain a high-risk sector, with relief priced in but not guaranteed. Chemicals and energy-intensive industries will not recover until energy costs are structurally lower.
What could change the story
The short-term outlook is bleak, but not hopeless. If the EU acts quickly to trigger the US tariff cut, German autos could see partial relief by early 2026.
If Merz manages to pass genuine reforms on pensions, energy and welfare, confidence would translate into investment. Public tenders for infrastructure and defence projects will filter into the real economy next year.
Still, the deeper issue is competitiveness. Merz has been blunt, saying Germany is in a “structural crisis” and that large parts of the economy are no longer price-competitive.
Unless energy costs fall predictably and regulatory burdens ease, any recovery will be temporary. The gap between Germany and more agile economies will widen.
The unique risk and opportunity
Germany might not enter a recession in 2025, but growth is off the table as well.
That makes the country’s trajectory unusually binary. Either reforms and spending deliver in 2026, giving Germany its first year of real growth since before the pandemic, or the optimism gap collapses and stagnation becomes entrenched.
Three signs to watch are the timing of EU legislation to cut auto tariffs, Germany’s industrial energy prices net of levies, and the delivery of infrastructure tenders. These will decide whether 2026 looks like 1% growth or closer to zero.
The world has grown used to Germany as an export powerhouse. The next two years will show whether it can reinvent itself as a balanced economy with domestic demand, competitive energy, and credible reforms.
For now, the data says stall. The hope is in the policy pipeline. Whether that hope becomes reality is the single biggest economic story in Europe today.
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