Germany is set to avoid a recession in 2026 because higher public spending on defense and infrastructure will counteract the economic hit from rising energy costs tied to the war in the Middle East, the Bundesbank said Friday.
In its latest outlook the central bank projected that the German economy will expand 0.5% in 2026, a downward revision from the 0.6% forecast issued in December. It also scaled back growth for 2027 to 0.8% from a previous forecast of 1.3%.
The Bundesbank released its update a day after the European Central Bank both lowered its euro zone growth forecast and raised interest rates in an effort to curb inflation.
Fiscal support and the near-term outlook
The Bundesbank said that expansionary fiscal policy will be the decisive factor preventing a fall in gross domestic product in the summer half-year and that it will largely offset the impact of the war in the Middle East. The bank expects government spending - with defense outlays singled out - to contribute a combined 1.3 percentage points to growth through 2028.
That planned increase in public expenditure had been anticipated to support recovery this year, after Germany's economy has remained broadly flat for three years. But the sudden rise in energy prices related to the conflict has disrupted that trajectory and weakened household purchasing power.
Headwinds for households, firms and investment
High energy costs are expected to erode household real incomes, the Bundesbank said. Firms face potential supply bottlenecks and softer demand as a result of these developments. On top of that, uncertainty and elevated interest rates are likely to constrain private investment, even as the bank expects the war's direct effects to ease in the years ahead.
In its outlook the Bundesbank stressed that risks are skewed in two directions: clearly tilted to the upside for inflation and to the downside for economic activity.
Inflation outlook
The central bank does not expect underlying price growth - that is, inflation excluding volatile food and energy components - to fall below the European Central Bank's 2% target through 2028. That projection underpins the Bundesbank's view that inflationary pressures will remain a persistent concern.
Implications
Overall, the Bundesbank presents a picture in which public sector spending keeps the economy out of recession in 2026, while elevated energy costs, supply constraints and higher borrowing costs weigh on households, businesses and private capital formation. The bank's assessment signals a sustained tension between policy-driven support for growth and persistent inflationary pressure over the coming years.