Germany’s RWI trims growth outlook, flags reliance on state spending

The Leibniz Institute for Economic Research (RWI) has significantly downgraded Germany's economic outlook, now projecting GDP growth of just 0.2% in 2025 and 1.1% in 2026. The RWI emphasized the economy's increasing dependence on substantial government spending, estimated at 0.9% of GDP annually from 2026, to offset weak private investment. The institute cautioned that this fiscal reliance is unsustainable and fails to address fundamental competitiveness issues, while also contributing to a rising government deficit.

Analysis

The Leibniz Institute for Economic Research (RWI) has materially downgraded Germany's economic outlook, signaling structural weakness in Europe's largest economy. The revised GDP growth forecast of a mere 0.2% for 2025 and 1.1% for 2026 highlights a significant deceleration, with the RWI attributing future growth almost entirely to government intervention. From 2026, fiscal stimulus equivalent to 0.9% of GDP annually is expected to be the primary driver, a measure the institute warns is an unsustainable substitute for flagging private investment and fails to address core competitiveness issues. This policy path is projected to expand the general government deficit from approximately 116 billion euros to 170 billion euros by 2027. Despite this stimulus, unemployment is forecast to remain elevated above 6%, while inflation is expected to stabilize around the European Central Bank's 2% target, painting a stagflationary picture of weak growth coupled with persistent inflation and high unemployment.

Key Decisions for Investors

• Given the downgraded German GDP forecast and weak private investment, investors should consider reducing exposure to German cyclical sectors, particularly industrials and consumer discretionary, which are sensitive to domestic economic health.
• The projected increase in the government deficit to 170 billion euros by 2027 implies higher future bond issuance, which could exert upward pressure on German Bund yields; therefore, a cautious or underweight position on long-duration German sovereign debt is warranted.
• The combination of structural economic weakness, reliance on fiscal spending, and persistent unemployment presents a negative fundamental backdrop for the Euro, suggesting that hedging EUR-denominated portfolio assets should be considered.
• Monitor unemployment figures closely, as the forecast for it to remain above 6% despite fiscal stimulus indicates deep-seated structural issues that could further dampen consumer confidence and spending.