The global economy was still in robust shape at the start of 2025. Anticipatory effects resulting from expectations of further US tariffs even appear to have stimulated global trade and industrial production temporarily. This is likely to be one reason why economic output in the euro area increased markedly in the last quarter. In China, the pace of growth remained solid at first. In the United States, while real gross domestic product (GDP) decreased slightly against a backdrop of a sharp upturn in imports, other indicators did not yet point to a significant deterioration in economic activity. 

From the second quarter onwards, the US’s pivot towards protectionist trade policy is likely to weigh increasingly on the global economy. Uncertainty over trade policy had already risen significantly in the aftermath of the election of the new US President. At the start of 2025, the new US administration then began to impose the first additional tariffs on imports from various countries. Further tariff increases followed. Trading partners resorted to retaliatory measures in some cases. Some of the tariff increases were then withdrawn. In trade between the United States and China, reciprocal tariff rates temporarily shot up to prohibitive levels. Recently, the average effective tariff rate of the United States for all trading partners was more than 13 percentage points higher than at the start of the year, putting it at its highest level since the 1930s. 1 Many trading partners of the United States are being threatened with further tariff hikes from July onwards in the event of negotiations to reshape bilateral trade relations failing. It is already apparent that the new tariffs and the ongoing trade policy uncertainty are proving an increasing drag on the global economy. According to business surveys, business expectations have deteriorated significantly over the last few months not only in the manufacturing sector but also in services. 

With the outlook for demand deteriorating, commodity prices have seen a broad-based decline. This was particularly true of energy commodity prices: as this report went to press, a barrel of Brent crude oil cost US$66, some 13 % less than as recently as February. In addition to the gloomier global economic outlook, this was also driven by the decision of some OPEC states to ramp up oil production significantly. European gas prices likewise fell markedly. The prices for industrial and food commodities also declined somewhat recently.

The global disinflationary process continues to unfold, but tariff hikes are likely to impede further progress in the United States. In the face of lower energy prices, the rise in consumer prices in advanced economies had weakened on the year to 2.4 % by April. The core inflation rate excluding energy and food decreased slightly to 2.8 %. Looking ahead, the huge tariff increases imposed by the United States can be expected to push up consumer prices there. In other advanced economies, low commodity prices and the appreciation of their currencies against the US dollar should generally support the ongoing process of disinflation over the coming months. 

International financial markets were also strongly influenced by political developments in the United States. For example, the US tariff announcements at the beginning of April triggered severe financial market reactions, which probably also showed that confidence in the safe haven status of the US currency had been damaged, at least temporarily. Some market participants also suspected that this policy initiative was part of a broader economic policy attempt to reduce the US trade deficit via a weaker US dollar. This perception was amplified by the US President’s repeated public and in some cases severe criticism of central bank officials. For all these reasons, market participants expected significant growth risks and investment risk for the US economy. The emerging concerns led to an extremely unusual financial market response: the US dollar came under marked broad-based downward pressure. At the same time, investors’ risk appetite slumped, leading to strong equity market losses amid high financial market volatility, and US Treasury prices fell markedly. The response thus differed qualitatively from the otherwise usual safe haven movements under financial market stress, in which the US dollar appreciates and US Treasuries gain in value. 

International government bond yields saw mixed developments amid high levels of uncertainty. Market participants’ concerns about a further significant slowdown in economic activity dominated at the beginning of the first quarter of 2025. The US government’s tariff announcements amplified these developments, but abruptly halted the previous decline in US yields and caused a surge in US yields over federal securities. This was partly due to the fact that Bund yields fell significantly, as they were regarded by investors as a safe haven. Looking at the entire review period, however, this was offset by the impact of high planned fiscal spending on defence and infrastructure in Germany and the rest of the euro area, which, taken in isolation, is associated with medium-term growth impulses from the perspective of market participants, thereby supporting the picture of higher longer-term real interest rates in particular. The expected increase in free float of Bunds in view of the anticipated issuance volume also contributed to the rise in yields. 

As a result of US policy, market participants’ risk appetite saw striking declines at times. The market for risky financial market investments thus came under massive pressure. For example, the tariff announcements led to sharp equity price losses, rising yield spreads on corporate bonds and an exceptionally strong increase in implied stock market volatility. However, the US administration’s announcement of a temporary suspension of a large number of tariffs then set a countermovement in motion and contributed to strong price gains, which more than offset the previous losses. The potential for downward corrections in the event of further volte-faces in US economic policy remains considerable. Given the comparatively favourable earnings outlook for European enterprises, the uncertainty still associated with US tariff policy weighed mainly on US earnings expectations. Overall, US equity prices rose slightly, while European equities recorded strong gains.

At its monetary policy meetings in March and April 2025, the ECB Governing Council adopted two further interest rate cuts. The deposit facility rate, through which the Governing Council steers the monetary policy stance, now stands at 2.25 %. The ECB Governing Council justified the interest rate cuts primarily based on the fact that the disinflation process was well on track: inflation has developed largely in line with the new projections drawn up in March. In its communication, the ECB Governing Council stressed the exceptionally high level of uncertainty currently emanating from international tensions and their potential implications for the euro area. Especially under such conditions, it will follow a data-dependent and meeting-by-meeting approach to determining the appropriate future monetary policy stance. 

The broad monetary aggregate M3 continued to grow in the first quarter of 2025; lending continued to recover. Monetary dynamics increasingly stabilised; the annual growth rate of M3 stood at 3.6 % at the end of March. The growth in M3 was due mainly to inflows to overnight deposits, whilst other short-term deposits declined again. This was driven by the continued policy rate cuts, which have now perceptibly reduced the yield advantage of short-term time deposits. On the supply side, banks’ lending to domestic non-banks was by far the most significant counterpart to monetary growth. Lending to households was the key factor here. However, loans to non-financial corporations also continued to rise. The progress of this recovery is likely to depend, not least, on the outcomes of current trade disputes and their repercussions for individual Member States. 

German banks’ lending business with the domestic private non-financial sector grew markedly in the first quarter. Lending to households for house purchase continued the recovery that has been observed since the third quarter of 2024. A more upbeat assessment by households of housing market prospects and the decline in the general interest rate level boosted demand for loans in this segment. By contrast, lending business with the non-financial corporate sector once again lacked any notable impetus. The subdued demand for bank loans among German enterprises mainly reflects the uncertain economic outlook. This is consistent with the BLS finding that banks tightened their credit standards again – albeit marginally – in the first quarter of 2024 on the grounds of a perceived increase in credit risk.

Economic output in Germany was up somewhat in the first quarter of 2025. According to the Federal Statistical Office’s flash estimate, real GDP was a seasonally adjusted 0.2 % higher than in the previous quarter, during which it had dropped by the same amount. Output in both industry and construction grew in the first quarter. The increase in industrial output was likely attributable not only to a somewhat better order situation overall, but also to anticipatory effects stemming from announcements that the US administration would raise tariffs. These effects likewise led to a significant increase in exports of goods. Private consumption also contributed to the increase in economic activity. The former was still benefiting from the sharp rise in wages last year. The higher levels of both industrial output and private consumption are likely to have supported service providers. Despite the headwinds from a high degree of economic policy uncertainty and low industrial capacity utilisation, investment in machinery and equipment looks to have risen. 

The labour market saw little change in the first quarter. After a sideways movement in the employment level in the fourth quarter, total employment remained unchanged on the quarter in the first three months of the year as well. As before, increased employment in services offset the decline in manufacturing. Unemployment saw a moderate uptick. The outlook remains subdued. 

Growth in negotiated wages was considerably weaker in the first quarter than in the quarter before. Including additional benefits, they were up by just 0.9 % on the year, compared with 5.8 % in the fourth quarter of 2024. The lower wage growth was mainly driven by negative base effects stemming from the high inflation compensation bonuses in the first quarter of 2024, which are not being paid this year. By contrast, if only basic pay is considered, year-on-year growth in negotiated wages of 6.7 % in the first quarter was similar to that of the fourth quarter. Actual earnings probably rose much more than negotiated wages in the first quarter of 2025.

Recent wage agreements have mostly been lower than before. Wage demands are also gradually declining. Owing to the period of economic weakness, uncertainty about future economic developments and lower inflation rates, wage agreements will probably continue to be much lower than in the past two years. The independent Minimum Wage Commission will deliver a recommendation for the adjustment of the statutory general minimum wage to the Federal Government by the end of June. The Commission can freely and independently decide how to use its statutory scope. If the statutory minimum wage were to be quickly raised to €15 per hour, as some politicians are demanding and as described as achievable in 2026 in the new coalition agreement, this would likely have a significant impact on negotiated wages in the craft trades, construction and labour-intensive services. The lower wage brackets in these sectors would then probably be raised substantially.

Inflation picked up somewhat in the first quarter of 2025. Consumer prices (HICP) rose by a seasonally adjusted 0.7 % on the quarter, compared with 0.5 % in the final quarter of 2024. This was due chiefly to the services sector. In addition, energy prices went up again on average in the first quarter, after having fallen in the two preceding quarters. By contrast, prices for both non-energy industrial goods and food rose only moderately at the start of the year and much less than in the final quarter of 2024. Annual headline inflation picked up again slightly (to 2.6 %) in the first quarter of 2025. Core inflation (HICP excluding energy and food), by contrast, held steady at 3.2 %. 

Price rises were moderate overall in April. The headline inflation rate dropped slightly from 2.3 % in March to 2.2 %. By contrast, the core rate saw a steep climb from 2.8 % to 3.1 % on account of dynamic services prices. Underlying inflation remains elevated by other measures, too, but has lost a great deal of momentum since the high inflation phase.

The inflation outlook is particularly uncertain at present, with inflation currently expected to fluctuate around the 2 % mark in the coming months. The still steep growth in the prices of services should gradually diminish. In addition, lower energy prices are likely to dampen the inflation rate. The government measures with direct price effects announced in the coalition agreement will push energy prices down further (e.g. lowering electricity tax and grid charges.) However, it is still unclear when the measures will be implemented. The inflation rate could then fall below 2 % for a while. 

The German economy is likely to tread water in the second quarter. A wide range of burdens persist and the US administration’s tightening of its tariff policy adds additional headwinds. This affects the export industry in particular, which is already struggling with a difficult competitive position and weak demand. Foreign demand for German industrial products remains weak. The US administration’s trade policy is weighing on the export outlook not only through imposed or threatened tariffs, but also through the steep appreciation of the euro associated with financial market responses. It is possible that the threat of even higher tariffs could lead to further anticipatory effects in the short term. In principle, however, advanced production or exports sooner or later lead to a rebound effect. Such burdens could well already emerge in the current quarter. The uncertainty associated with the tariff conflict also affects planning certainty and thus firms’ propensity to invest. The latter is also being weakened by the still low capacity utilisation in industry. The drag on investment from previously higher financing costs is expected to gradually subside but banks tightened their credit standards for loans to enterprises again marginally in the first quarter amid uncertain macroeconomic conditions. Construction investment could more or less stagnate. This is because demand for construction work is not yet so stable that stimulus can be expected in the short term. Private consumption could once again provide some impetus. Labour income is not expected to provide any impetus in the short term, but consumer sentiment brightened in April according to surveys conducted by the market research institution GfK. 

The measures agreed in the coalition agreement are likely to support economic activity in the coming years. However, before new infrastructure projects generate additional orders in the construction sector, planning, approval and procurement procedures must first be followed. Even if these are to be accelerated significantly, marked stimulus for construction output is not to be expected until next year at the earliest. Furthermore, its strength also depends on the available production capacity. It is expected that plans for accelerated depreciation options will strengthen firms’ investment in machinery and equipment. After the necessary administrative lead time, higher defence expenditure will be reflected in higher government investment and consumption expenditure. While the higher demand is likely to benefit suppliers abroad, partly as a result of higher imports, it is not least domestic manufacturers of armaments that are ultimately likely to benefit from this. The higher aggregate demand could lead to somewhat higher inflation rates in the medium term. However, the coalition agreement also includes some fiscal measures that temporarily dampen inflation directly, especially in the case of energy. Specific macroeconomic effects of the more expansionary fiscal policy will be estimated more precisely in the Bundesbank’s new Forecast for Germany. This will be published in June. 

The new Federal Government’s coalition agreement contains some supply-side projects that can strengthen the long-term growth of the German economy. This is particularly true of measures to improve the business investment environment. These include projects to reduce bureaucracy, modernise government administration and digitalisation, as well as the planned tax incentives for investment. Measures to boost innovation, such as better access to venture capital for young firms, can also play a part. For many projects, the impact on growth will depend in large part on the actual implementation. A coherent overall concept has yet to be drawn up for the energy transition. Energy transition costs can be limited through efficiency-enhancing measures and market-based mechanisms. Some of the new government’s plans are aimed in this direction. Certain individual measures will boost the labour supply. For example, the planned civic allowance reform is likely to increase the incentives of unemployed persons to search for a job, thereby boosting the labour supply. By contrast, the measures to enhance the immigration of skilled workers are only partially convincing. In addition, there are a number of instances where domestic labour market reserves could have been used to a greater extent.

German fiscal policy is changing course: the deficit and debt ratios are likely to rise significantly over the next few years. The debt brake has been relaxed in German law, thus considerably expanding the scope for government borrowing. According to the coalition agreement, fiscal policy will make use of this expanded scope. Considerable additional expenditure on defence and government infrastructure, but also on subsidies and pensions, is currently expected. Demographic-related spending pressure will also compound the situation. All in all, then, the structural expenditure ratio could far exceed 50 % in the coming years. On the revenue side, higher contribution rates to the pension, health and long-term care insurance schemes are envisaged because their expenditure is growing dynamically. The tax wedge ratio is therefore likely to increase despite the announced tax relief. All in all, the general government deficit ratio could reach around 4 % in 2027. However, the deficit ratio could initially decline somewhat this year (from 2.8 % in the previous year), as tax revenue is growing markedly, social contribution rates are rising robustly, and the fiscal realignment will probably have little impact yet due to the necessary lead time. 

Germany is facing major economic and defence policy challenges, and it is important to tackle them quickly. Owing to the relatively good starting position of government finances, deficits that are significantly higher temporarily can be coped with easily. 

Persistently high deficits would not, however, be compatible with sound public finances or EU rules. Rising and high interest burdens would severely restrict fiscal room for manoeuvre and high debt ratios would damage the resilience of public finances. The EU rules (including EU treaty provisions) generally aim to lower debt ratios that exceed 60 % – and for good reason. Binding EU fiscal rules are a key anchor for sound public finances and a stability-oriented monetary union. 

The EU requirements for German public finances will be significantly tighter than the new national scope for borrowing, at least following a transitional period. At present, there is still no clarity regarding the specific national and EU requirements. For example, the reformed national rules still lack implementing laws. For the EU level, Germany must first agree on a fiscal plan for the current four to seven-year planning period. Second, it is still unclear what additional scope the requested escape clause will allow for higher defence expenditure. However, after a period of temporarily loosened EU requirements, Germany will probably have to aim for a structural general government deficit ratio of around 1 %. This roughly corresponds to the average annual scope for borrowing of the new infrastructure fund. Looking ahead, the new national scope for borrowing will therefore only be available in part.

In their upcoming decisions, central and state governments should already take into account that general government deficits will have to fall again considerably in the future. It would be logical to limit this foreseeable need for correction from the outset by reserving the newly created scope for borrowing solely for addressing the current challenges in defence and infrastructure investment (including climate neutrality). Other additional measures would then have to be counterfinanced. In this context, it would also be a good idea to quickly mobilise efficiency reserves, for example by way of a digital administration, and to reduce subsidies. In addition, the tax and transfer system could be reviewed and, in particular, made more efficient and more targeted. The coalition agreement also envisages changes along these lines. At the same time, however, it also holds out the prospect of numerous new tax exemptions and selective subsidies. Important levers for higher labour force participation are likely to go unused. Among other things, it would make sense to abolish special rules for early retirement and to allow the statutory retirement age to rise further from 2031 onwards as life expectancy increases. This would make the pension insurance scheme more employment-friendly and make public finances more resilient to demographic developments, and the multi-year lead time would give employees and employers planning certainty.

It would be advisable for legislation on the amended debt brake to once again lay out reliable guidelines for Germany’s public finances. In the forthcoming implementation laws, it would be advisable to reserve the new scope for borrowing for those measures addressing the challenges of defence and infrastructure investment (including climate neutrality) that go beyond what was achieved in 2024. The area of application and additionality could therefore be specifically safeguarded. In addition, central and state governments could set out how they will bring their respective national scope for borrowing for the current transition phase into line with the (yet to be agreed) EU requirements for the fiscal plan and escape clause. This would provide greater transparency and would be particularly important if EU rules are narrower than national leeway.

In the announced further reform of the debt brake, sound public finances and the objectives of the EU rules can also be re-anchored in the Basic Law via binding credit limits. This is because it would be incompatible with it to largely exempt defence-related expenditure from the debt brake on a permanent basis. By contrast, the Bundesbank’s proposals for a fundamental reform of the debt brake continue to offer suitable approaches for a rule that is sustainable in the long-term. They aim to give priority to government investment (in infrastructure and defence) as well as to safeguard sound public finances and EU rules.