Non-final working translation

The global economy remained resilient in the second quarter of 2026. In the United States, the overall economic upturn continued in the second quarter, more or less maintaining its previous pace. Growth strengthened in the euro area after being dampened in the first quarter by the sharp decline in Irish GDP. Excluding Ireland, economic output rose moderately again in the euro area. In China, GDP growth slowed markedly in the second quarter, but given the ongoing export boom the underlying economic dynamics are likely to have performed better. Overall, the global economy has thus far held up quite well despite the burdens arising from higher energy prices and ongoing trade and geopolitical tensions.

The burdens on industrial production and global trade stemming from the conflict in the Middle East have so far remained confined to specific regions. Although industrial production fell sharply in the oil-exporting economies of the Gulf region as a result of military conflict, industrial production and exports of goods continued to increase in the advanced economies. They were mainly supported by persistently buoyant global investment demand in connection with high-tech and AI applications. The latest sentiment indicators suggest that economic activity in advanced economies has been robust of late. 

Energy commodity prices have remained significantly elevated recently, given the volatile geopolitical situation. Oil prices fell sharply in June after the United States and Iran agreed on a memorandum of understanding and shipping via the Strait of Hormuz resumed temporarily. In July, however, prices intermittently picked up again as a result of new military attacks and the renewed blockade of the Strait. At last report, Brent crude oil cost US$92 per barrel, around 29 % more than before the war began. Oil price futures suggest that prices will fall slightly until the end of the year. However, the upside risks remain considerable given reduced global inventories and possible further supply outages in the event of a regional expansion of the conflict. 

Energy prices continued to drive inflation in advanced economies. The year-on-year increase in consumer prices amounted to 3.1 % in July, after reaching 3.3 % in April and 3.7 % in May. Excluding energy and food, inflation stood at 2.4 % in July. If energy commodity prices remain elevated for longer, enterprises are likely to increasingly pass on the associated costs to consumers. In addition, the global investment boom in artificial intelligence is increasingly driving up the prices of individual goods. Prices not only for intermediate products such as semiconductors and memory modules but also for computers and software and accessories have recently risen significantly. Although their contribution to consumer price inflation is likely to be limited due to their low weight in the baskets of goods, they could further amplify underlying cost and price pressures.

From early April to mid-August, mounting short-term interest rate expectations and rising term premia increased long-term sovereign bond yields. In the euro area, market participants had already priced in key interest rate increases before the start of the reporting period. This was in response to the energy-related inflation risks triggered by the outbreak of the Persian Gulf war. With the resurgence of the fighting in July, market participants revised their expectations for the future policy rate path further upwards. In the United States, a shift in communication under the new Fed chair and robust economic data caused expected future short-term interest rates to rise. In addition, a higher term premium contributed to the rise in US yields. Based on the model analyses, varying monetary policy impulses from the United States had a significant impact on the euro-US dollar exchange rate. The euro appreciated slightly on balance against the US dollar. However, it depreciated in trade-weighted terms.

The prices of risky assets displayed a mostly positive trend, supported by a higher risk appetite, increased earnings expectations and the ongoing AI boom. Risky assets gained markedly in value in the reporting period from a subdued level; phases of de-escalation in the Middle East additionally supported the risk appetite. Equity and high-yield corporate bond prices continued to rise. The risk premia of corporate bonds in the high-yield segment showed a particularly marked narrowing. In equity markets, higher earnings expectations and the ongoing AI boom led to price gains. Technology stocks, in particular, rose sharply. However, earnings expectations rose even faster than prices. The implied cost of equity thus also increased. This means that, all in all, equity valuations are cheaper than at the beginning of the second quarter. However, doubts repeatedly surfaced as to whether the high investment in the AI sector could generate corresponding earnings on a permanent basis. 

At its monetary policy meeting in June 2026, the Governing Council decided to raise the three key ECB interest rates by 25 basis points. The Governing Council’s decision was based primarily on the inflation pressures generated by the war in the Middle East and the perception of clearly upside risks to the inflation outlook. With this interest rate step, monetary policymakers are in a more favourable position to respond to these risks in an environment of high uncertainty. In July, the Governing Council left key ECB interest rates unchanged but made it clear that it did not rule out further interest rate hikes. 

Lending to non-financial corporations increased in the second quarter and monetary dynamics remained broadly stable. The growth in lending to enterprises was due to temporary factors such as catch-up effects following the slump in demand for investment loans at the outbreak of the war in the Middle East. In addition, there was a favourable setting for funding costs, an increase in financing needs and expanded investment activity in the euro area. The moderate lending activity to households did not pick up any further, meanwhile. 

The annual growth rate of M3 stood at 3.3 % at the end of June, within the range observed in the previous quarters. Short-term time deposits saw the largest inflows during the reporting quarter. Their higher remuneration made them noticeably more attractive. 

The German economy expanded markedly once again in the second quarter of 2026. According to the Federal Statistical Office’s flash estimate, real GDP rose by 0.2 % on the quarter after seasonal adjustment. Economic output had already risen quite steeply by 0.4 % in the previous quarter. However, this only became known when GDP data were revised at the end of July and therefore could not feed into the Bundesbank’s June forecast. In the face of many burdens, the German economy is thus now proving more robust than previously expected. This is also consistent with the latest revisions by the Federal Statistical Office, which suggest that economic momentum had already been more favourable than previously assumed as of the end of 2023. Taken together, this points to a somewhat stronger underlying cyclical trend at the current end. This means that the German economy is now clearly on a recovery path that not even the war in the Middle East has been able to stifle. In line with this, lending to non-financial corporations picked up markedly in the second quarter. Current developments thus represented a departure from the largely weak and often declining lending seen in recent quarters. At the same time, banks tightened their lending conditions for corporate clients again in the second quarter. They cited, in particular, industry-specific and firm-specific risks and subdued economic prospects.

Exports, in particular, are likely to have contributed to GDP growth in the second quarter. German industry was also bolstered by the persistently robust demand from abroad. It thus proved quite resilient to higher energy prices and supply chain problems. However, the recovery is unlikely to have provided a positive boost to private investment in machinery and equipment. Capacity utilisation in the manufacturing sector remained at a low level, and the increased uncertainty as a result of the outbreak of the war in the Middle East and higher interest rates acted as an additional drag. Despite weak housing demand and high construction costs, the construction sector is likely to have made a positive contribution to GDP growth. This is a result of temporary backlog and catch-up effects following weather-related lower output in the first quarter. Developments among service providers remained mixed. According to the data available up to May, less consumer-oriented services were the main contributors to GDP growth. By contrast, household consumption and related sectors are likely to have grown only moderately. This can be attributed to the deterioration in labour market conditions and the significant rise in consumer prices in the wake of the war in the Middle East.

The labour market has not benefited from the economic growth and continued to deteriorate in the second quarter. Employment declined further at a pace similar to that seen since mid-2025. Based on the usual revision of the national accounts, developments in total employment over the past two years are now also somewhat less favourable than when last reported. However, unemployment only rose marginally. Leading indicators provide little indication of an imminent improvement. 

In the second quarter of 2026, growth in negotiated wages was weaker than before. Both with and without special and one-off payments, they were up by only 2.6 % on the year. A key reason for this is that the latest wage agreements provided for lower increases than in previous years. So far, there are no indications that the war in Iran is triggering second-round effects on the inflation rate via higher negotiated wages. Actual earnings probably rose at a similar rate in the second quarter as in the first quarter, when they grew by just over 4 %. They therefore once again probably rose significantly more strongly than negotiated wages. 

Consumer prices increased sharply in the second quarter. Consumer prices (HICP) appreciated by a seasonally adjusted 0.9 % on the quarter in the second quarter of 2026, compared with 0.7 % in the first quarter. The annual inflation rate also increased markedly in the second quarter of 2026. Inflation rose to 2.6 %, after having been close to 2 % in January and February. The energy price shock thus interrupted the disinflation process, which had made major progress up to that point. In contrast to the previous period of high inflation, however, the renewed rise in inflation has so far not been broad-based, but instead focused heavily on energy products. Indirect effects of the energy price surge on other components of the HICP have so far been limited. Unlike the headline rate, core inflation (as measured by HICP excluding energy and food) dropped slightly from 2.5 % in the previous quarter to 2.4 %. 

Following a brief decline in June, the inflation rate went back up significantly to 2.8 % in July. Energy prices, in particular, went up markedly more than before. The temporary energy tax cut for petrol and diesel expired and refining margins increased further. Price inflation also increased significantly in the case of non-energy industrial goods. This was due, in particular, to the sharp rise in prices for medicines, which is probably related to changes in the way pharmacies are regulated that came into effect on 1 July. Core inflation (i.e. excluding energy and food) rose from 2.5 % in June to 2.6 % in July.

The inflation rate could temporarily rise further in the coming months. The outlook remains largely dependent on the course of the war in the Middle East. In addition to crude oil prices, refining margins, in particular, are important for short-term developments in fuel and heating oil prices. War-related damage to refineries in Russia and the Middle East, together with the blockade of the Strait of Hormuz, are already squeezing the global supply of petroleum products. If energy prices remain high at upstream stages or continue to rise, cost pressures could increasingly be transferred to the consumer prices of other goods and individual services.

In the third quarter, the consequences of low water levels on major waterways are likely to temporarily slow the recovery of the German economy. The German economy is starting the second half of the year with an ongoing fairly strong underlying cyclical trend. The robust order situation in industry offers good conditions for continued positive export growth. Government spending is also likely to provide continued impetus to economic dynamics. In addition to higher defence expenditure, a gradual rise in infrastructure investment could gradually become more noticeable. At the same time, however, several stress factors remain, and the pronounced drought period is temporarily adding further restrictions. Only limited availability of transport routes on major rivers and sharply rising transport costs are likely to significantly hamper industrial output and the increase in exports. The low water levels are thus also placing a marked strain on overall economic activity in the third quarter. Furthermore, the ongoing low capacity utilisation in industry and the recent rise in interest rates are curbing firms’ investment. Among service providers, those in less consumer-oriented sectors are likely to expand further. However, consumer-oriented service providers are likely to remain under pressure. Private consumption is being depressed by persistently high energy prices. The weak labour market and pessimistic income expectations according to GfK data are also contributing to households’ continued low propensity to consume. Finally, weaker demand for housing construction is likely to dampen construction activity. Overall, the recovery in the German economy is likely to temporarily lose significant momentum in the third quarter. 

German public finances are on an expansionary course, mainly owing to sharply rising expenditure. According to the current trajectory, the general government deficit ratio is heading towards 5 % by 2028 (2025: 2.8 %). Higher defence expenditure is the main contributory factor, followed by growing transfers, higher non-military investment expenditure, increasing interest burdens and tax cuts. 

Central government is planning very large deficits up to 2030. Savings to comply with the debt brake have already been factored in without the corresponding measures being specified. According to the new budgetary and fiscal plan, central government’s structural deficit will increase to 4¼ % of GDP in 2030. Without the unspecific savings to comply with the debt brake, the ratio would actually exceed 5 % in 2030. 3 percentage points of the high structural deficit ratio are attributable to the defence exemption and 1 percentage point to the Special Fund for Infrastructure and Climate Neutrality. The expanded scope for borrowing is being utilised without defence and infrastructure expenditure growing correspondingly.

A number of important and extensive structural reforms are under way and will be a welcome development. For example, the Federal Government is working to ensure that the social security funds are stable and reliable on a lasting basis, thereby limiting the rise in contribution rates. Other measures are aimed, for example, at improving administrative processes and reducing bureaucratic burdens. Here, in particular, it will be important for the various levels of government to take a comprehensive and coordinated approach. 

On the topic of old-age pensions, the Pension Commission has proposed a groundbreaking package of measures. It is right that the Federal Government wants to implement this in full. The proposed measures would strengthen employment, particularly through higher statutory retirement ages. At the same time, they would dampen the financing pressure on the pay-as-you-go system utilised by the statutory pension insurance scheme. As a result, the contribution rate in the pay-as-you-go system can be lower and relief would also be provided for the central government budget. A new mandatory funded pension is intended to supplement the pay-as-you-go pension and exploit the return opportunities of longer-term capital market investments. The aim is to raise the overall replacement rate from unfunded pay-as-you-go and funded components to well above the current replacement rate in future. Central government guarantees a minimum replacement rate of 48 % upon retirement (for the standard pension). In this respect, it assumes part of the burdens and risk arising from the transition.

It is now important to implement the various reforms swiftly and to use the reform momentum for sound public finances too. The earlier the reform measures enter into force, the earlier they can improve growth conditions and ease the burden on public finances and the social security system. In order not to simultaneously jeopardise the resilience of public finances, it is important for there to be a credible prospect of deficit ratios falling again. For central government, this means using concrete measures to resolve outstanding consolidation needs in its plans and starting to reduce the deficit towards the end of the financial plan’s timeline. However, with the current plans, Germany is at risk of violating EU fiscal rules. 

Credible and stability-oriented fiscal rules are important for Germany and the EU. The current debt brake and the EU rules currently allow for large deficits and are also interpreted broadly. In view of high deficit and debt ratios in some Member States, the future application and interpretation of the rules should be clearly focused on swiftly achieving sound public finances. This also implies that the current EU defence exemption should not be extended to other areas. In Germany, a reform of the debt brake is important in order to re-establish stable guardrails for sound public finances. The Bundesbank has put forward a proposal on the matter.