DIW: Rising energy prices and trade fluctuations are slowing down the German recovery, but are not enough to push the economy into another downturn.

The German Institute for Economic Research (DIW), one of Germany's leading economic research institutions, stated on Wednesday that the significant increase in energy prices resulting from the current war between the US/Israel and Iran, as well as the US government's "fickle" trade policies in recent years, are expected to slightly suppress the process of economic recovery in Germany this year. As one of Germany's main authoritative economic forecasting institutions, DIW predicts that despite the unfavorable impact of the sharp rise in energy prices on the expansion of the German economy, government investments rebounding and strong consumer resilience will lead to a 1% growth in Germany's gross domestic product (GDP) this year, followed by a 1.4% growth in 2027 after a minimal increase of only 0.2% in 2025. The institute stated that the strong public consumption and gradual recovery of government investments, focusing first on the defense industry and subsequently on infrastructure construction including AI data centers, will jointly drive the continuation of the economic recovery in Germany in early 2026. The institute noted that the recent Supreme Court decision in the US to overturn many of President Trump's global tariff measures has not had a significant impact on German exports so far, as Trump subsequently introduced a global 10% tariff for 150 days and may soon increase it further to 15% - similar to the equivalent tariff measures announced in April 2025. Meanwhile, DIW stated that the recent increase in core energy prices such as natural gas due to escalated geopolitical conflicts in the Middle East is significantly lower than the levels during the European energy crisis from 2022 to 2023. Assuming that the strongest surge in energy prices has passed and oil and gas prices will only moderately rise, this might push inflation up by 0.4 percentage points this year and slow down economic growth by 0.1 to 0.2 percentage points. In its research report, DIW stated, "Overall, this will slow down the recovery of the German economy, but it will not bring it to a standstill." The institute predicts that the inflation rate in Germany will be 2.4% in 2026, slightly decreasing to 2.3% next year, and the institution expects that the European Central Bank will not choose to raise interest rates further. Although European Central Bank officials call for patience, the market has already factored in the possibility of the European Central Bank raising interest rates twice this year to counteract the sharp rise in inflation caused by energy prices. European natural gas prices have almost doubled compared to before the outbreak of the war between the US/Israel and Iran, and last week, the suspension of supplies by Qatar caused European natural gas prices to soar by about 50% in a single day. As concerns and fears about inflation and the economy heading towards "stagflation" intensify due to the soaring energy prices, traders are increasing their bets on the European Central Bank and the Bank of England starting a cycle of rate hikes. In contrast, before the outbreak of the war between the US/Israel and Iran, the market had once bet on the European and British central banks continuing to cut interest rates in the second half of the year. "Stagflation" is arguably the most difficult long-term economic challenge for central banks worldwide, including the Federal Reserve and the European Central Bank. According to the forward market, traders currently estimate a probability of around 70% for the European Central Bank to raise interest rates by 25 basis points twice this year, whereas last Friday, the market only factored in one rate hike with a probability hovering around 50%. The first rate hike is already fully priced in by the market, expected to take place in July or earlier. Meanwhile, currency market traders currently believe that the probability of the Bank of England announcing a rate hike before the end of the year is about 50%, completely reversing the bets on a cycle of rate cuts that existed last week. Sentix, as a leading sentiment indicator, showed that the investor confidence index in the eurozone dropped significantly from 4.2 in February to -3.1 in March, ending three consecutive months of improvement; with the expectation sub-index falling significantly from 15.8 to 3.5 and the German sub-index worsening from -6.9 to -12.1. Sentix directly defined this as the "first economic indicator" after the outbreak of the war in Iran, suggesting that this casts considerable doubt on the momentum of economic recovery in Germany and the entire eurozone. The flames of war in Iran are pushing Germany and the eurozone into a vulnerable macroeconomic regime of "low growth + higher inflation risk," but it is premature to conclude that Europe will fall back into a full recession. The key to growth risk at the macro level lies not in the current surge in oil and gas prices, but in whether the energy shock will last long enough to spill over into broader consumer inflation and tighten financial conditions.