German economy wages a losing war on inflation amid recession fears

European recession
The Russia-Ukraine war may lead to a European recession that threatens to destroy Europe’s industrial prowess and high living standards.

German economy struggles against Ukraine conflict fallout: The Russian invasion of Ukraine triggered tough western sanctions that were expected to bring Moscow to its knees in no time. But more than six months into the conflict, the Russian economy is still on its feet, contrary to the expectations of the western powers. The European backers of Ukraine who were hoping for a swift end to the Ukraine conflict seem to be in a spot of bother. Most of these countries are heavily dependent on Russian oil and gas for their energy needs. With the war prolonging, the European countries are fighting simultaneous wars against runaway inflation and a recession.

The biggest loser in the crisis seems to be Germany, where annual inflation is threatening to breach 10% as it struggles to ward off a recession in the winter months. The German economy is dependent on Russian gas to fuel its energy-guzzling industry and home heating requirements. Russia can inflict pain on Europe’s largest economy by cutting off energy supplies. The Bundesbank has warned of uncertainty over gas supplies this winter and a sharp rise in prices as Russia is curtailing its gas supplies to Europe in retaliation to Western sanctions.

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German economy in spot of bother

The cut in gas supplies and heavy energy prices have affected consumption, and the country’s industrial sector has suffered greatly. Rising energy cost is fuelling inflation to levels unseen in decades. Annual Inflation rose to a 40-year high of 8.5% in July, forcing Germany to offer relief to help people meet soaring cost of living. The Bundesbank’s target annual inflation is 2%.

“Declining economic output in the winter months has become much more likely… Overall, the inflation rate could reach 10% in autumn. The upside risk for inflation is high, in particular in the event of a complete stoppage of gas supplies from Russia,” the Bundesbank says.

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Bundesbank president Joachim Nagel recently said that inflation will not go away in 2023 also as supply bottlenecks and geopolitical tensions are likely to continue. The energy crisis is just one of Germany economy’s problem. A disruption in global trade is chipping away at its powerful manufacturing industry and deficient rainfall adds to its problems.

Germany posted a trade deficit in May for the first time since 1991 because of supply chain disruptions and high energy prices. Exports have been a major source of growth for the world’s fourth-largest economy. It registered a trade deficit of $1 billion in May as exports fell 0.5% and imports rose 2.7%. Germany’s poor export performance reflected on the eurozone’s 24.6-billion-euro trade deficit, compared with a surplus of 17.2 billion euros in April.

Russia, which supplies about half of Germany’s gas requirements and a third of its oil requirements, has cut supplies, blaming technical glitches in its Nord Stream 1 pipeline. Rising mercury and months of no rainfall resulted a sharp fall in water levels in the Rhine river, a vital industrial transport route, disrupting movement of coal to power plants and industrial products for consumption and export.

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The energy crisis has forced Germany to impose a gas levy for its households which will be in force from October till April 2024. The gas levy of 2.419 cents per KWH will push up the energy cost for a family of four by 240 euros in the last quarter of 2022. It has announced an energy support package of €30 billion that includes a €300 lump sum to workers, additional amounts for people on social security support, tax cuts on petrol and diesel, and discounted bus and train travel.

Worries about a possible rationing of gas supplies for heavy industry are growing. Germany will have to cut its gas use by 20% if it is to avoid a shortage this winter. All companies have been asked to reduce the minimum room temperature at workspaces to 19 degree Celsius during winter months.

The economy has recorded its weakest economic performance among large eurozone countries in the second quarter of 2022. The IMF has cut its forecast for 2023 by 1.9 percentage points to 0.8%. All major think tanks also have cut growth estimates for the economy and raised inflation forecasts. The pessimism among investors about the German economy is growing and only a miracle can save the country from a recession.

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Anil Nair is Founder and Editor, Policy Circle.