But despite the reprieve in what has been a steady drumbeat of bad economic news for Merz until this point, economists warned of more trouble ahead, including rapidly rising debt levels and rising political turmoil.
Forecasters for Germany’s five leading economic institutes warned that domestic political developments could weaken the outlook going forward, warning the German coalition is backpedaling on needed but unpopular reforms to the healthcare and pension systems in the wake of historic AfD wins in regional elections this September.
“The economy has performed more robustly than expected,” said Oliver Holtemöller, head of economic forecasting at the Halle Institute for Economic Research. “However, the recovery rests on a narrow foundation, weighed down by high energy prices and structural problems.”
Holtemöller warned that Germany’s demographic decline — with more people leaving the workforce than entering it — bodes poorly for the economy. That problem, he said, could be compounded by rising populist forces that make Germany less attractive to highly qualified workers.
“One solution would be to have a country that is open to immigration of skilled workers,” Holtemöller said. “But when I look at current trends — and at the results of recent state elections — it’s clear that many people don’t want that.”
The AfD came in first in two regional elections in eastern Germany earlier this month, while Merz’s center-right conservatives suffered historic defeats.
The far right’s success has prompted members of the coalition government to reconsider parts of Merz’s reform agenda, which has proved unpopular with an increasingly restive electorate.
But economists warned that an inconsistent course would scare off investors.
“When reform packages are announced, unpacked, and then postponed on a quarterly basis … that leads to what we call a wait-and-see attitude among investors,” said Stefan Kooths, a professor at the Kiel Institute for the World Economy. “People hold back at first because they don’t know what to expect — what the framework conditions will be here in Germany. And for that reason, unclear economic policy also plays a role in Germany’s overall weak performance.”
Private consumption and business investment remained weak in Germany as higher energy prices linked to the war in Iran squeezed household purchasing power, the economists said.
Relief for consumers remains far off. Inflation is projected to reach 2.8% this year, rising to 3.2% in 2027 before easing to 2.0% in 2028, according to the forecast.
Economists also warned that rising German borrowing risks creating instability in the eurozone if left unchecked.
The government’s deficit is set to rise from 4.1% of GDP this year to 4.7% in 2028, the institutes warned.
“I see a major danger in the fact that Germany could come into conflict with the European fiscal policy framework,” if the country fails to consolidate its spending, Holtemöller said. “And then we would not only have a problem with the interest burden on public budgets, but we would also have a stability problem in the eurozone.”
