Germany—Europe’s faltering export powerhouse raises recession risk

Germany posted a €1 billion trade deficit in May; the first trade deficit of the world’s fourth largest economy and Australia’s 15th largest export market since 1991. The deficit was caused by surging energy import prices resulting from Russia’s invasion of Ukraine; EU natural gas prices are up sixfold on the year-earlier period in July. Germany’s export-oriented industrial sector is also facing headwinds, owing to higher business input costs (Chart), materials shortages and weaker external demand. In particular, record consumer price inflation in the euro zone is eroding real incomes, weighing on demand for German goods (Europe absorbed 65% of German merchandise exports in 2020).

Germany is the economic powerhouse of Europe. A weaker outlook for Germany’s large and sophisticated export and industrial sectors increases the risk of Europe entering recession. Particularly given consumer confidence is already in recession territory, with GfK's Consumer Confidence Index falling to a record low in July. Weaker German industrial production will also have global implications, with disruption to the EU’s intermediate goods manufacturing cycle likely to renew supply chain pressures that had recently eased.

Further, downside risks are rising. The IMF warns that the global economic outlook has ‘darkened significantly’ with multiple crises intensifying. Russia announced plans to reduce gas flows to Europe through Nord Stream I to 20% of capacity this week. Any prolonged hiatus in Russian gas supply increases the risk of acute energy shortages and possible state rationing of natural gas to German businesses. The European Commission warns that EU GDP could contract 0.4% to 1.0% were Russian gas supplies to be halted in the coming European winter, assuming average temperatures and preventative measures are taken to save energy. Reflecting these headwinds, the euro has fallen 10% over 2022 and briefly touched parity with the US dollar for the first time in 20 years this month.