The German economy is set to shrink in 2023 after a weak start to the year. As consumers continue to rein in spending because of stubbornly high inflation, Bundesbank president Joachim Nagel said on Friday.

Projected Contraction

Europe’s largest economy is projected to contract by 0.3% in 2023, according to the central bank’s latest forecasts.

Falling Energy Prices and Outlook Improvement

In December, the Bundesbank was still expecting a 0.5% contraction, but it said falling energy prices had slightly improved the outlook.

High Inflation Affecting Consumers’ Purchasing Power

“The German economy is still struggling with the consequences of high inflation. This is reducing citizens’ purchasing power,” Nagel said in a statement accompanying the forecasts.

Mild Recession Due to Energy Crisis and Higher Interest Rates

Germany unexpectedly slipped into a mild recession in the final months of 2022 and the start of 2023, as the energy crisis sparked by Russia’s invasion of Ukraine and higher interest rates took their toll on companies and households.

Recovery Expected to Gain Momentum by 2024-2025

Although the economy was “slowly regaining its footing” after the winter slump, it will take until 2024 and 2025 for the recovery to really gain momentum, Nagel said.

GDP Growth Projections

German gross domestic product (GDP) is growing by 1.2% in 2024 and 1.3% the following year, boosted by “declining inflation, strongly rising wages and a robust labor market.”

Inflation Expectations

This year, the Bundesbank expects inflation to reach six percent, down from a previous estimate of 7.2%, “due to energy price developments.”

Monetary Policy Action Needed to Counteract Risks of Persistent Inflation

“We are witnessing a welcome decline in inflation, but we’re still far from giving the all-clear signal,” Nagel said.

The warning came a day after the European Central Bank raised interest rates by a further 0.25 percentage points and signaled another hike in July.

ECB president Christine Lagarde cautioned that although inflation has been coming down, higher wages and corporate profits risked adding to price pressures – concerns echoed by Nagel.

“Decisive monetary policy action is key to counteracting the economic and societal risks of more persistent inflation,” he said.