German Central Bank Warns of Potential Recession Due to US Tariffs

The President of the German Central Bank, Joachim Nagel, warned on March 12 that US tariffs could push Germany, Europe's largest economy, into recession. This warning comes at a critical time as Berlin debates potential reforms to its fiscal policy.

“We are now in a world of tariffs,” Nagel stated in a podcast interview with the BBC, emphasizing that if tariffs are indeed implemented, Germany might face an economic downturn this year. He pointed out that global tariffs could exacerbate the existing symptoms of Germany’s “stagnant economy.” The country has already experienced two consecutive years of contraction, impacted by the lingering effects of the COVID-19 pandemic and the energy crisis arising from Western sanctions due to Russia’s invasion of Ukraine.

Just months after inflation and interest rates in the eurozone began to decline, former US President Donald Trump’s heavy tariff strategy resurfaced, causing market unease and straining traditional ties between Europe and its Atlantic allies. On March 12, the EU retaliated against the 25% tariffs on steel and aluminum imposed by Trump, announcing a series of anti-tariff measures starting in April that will affect €26 billion ($28.26 billion) worth of US goods.

“This is not a good policy,” Nagel lamented about the current “structural changes” facing the world, expressing concern that Americans will ultimately bear the highest costs of these tariffs. Given that Germany is the world’s third-largest exporter, with the US being its primary import market, the country is particularly vulnerable to the impacts of tariffs, especially in its automotive and machinery sectors.

According to the World Bank, in 2023, exports of goods and services accounted for 43.4% of Germany’s GDP. Despite typically high trade surpluses, recent data from the Federal Statistical Office shows that Germany's trade surplus fell to €16 billion in January from €20.7 billion in December.

With ongoing uncertainties regarding US support for Ukraine, the EU recently unveiled a “rearmament” plan amid rising tariff-related uncertainties, potentially relaxing budget constraints to accommodate increased defense spending. Fitch Ratings warned that this plan could mobilize nearly €800 billion in defense expenditures, posing risks to the EU’s current AAA rating but not leading to an immediate downgrade.

As discussions around reforming Germany’s so-called “debt brake” intensify, conservative leader Friedrich Merz, a likely candidate for Chancellor in the upcoming ruling coalition, has proposed changes to allow for increased defense spending. This initiative has spurred a rise in German government bond yields and stock market indices.

The plan combines fiscal reform proposals with a €500 billion infrastructure fund, facing resistance from the Green Party. Merz’s conservatives and potential coalition partner, the Social Democrats, must persuade the Greens to secure the two-thirds majority needed to amend the constitutional debt brake.

Before parliamentary debates on the potential reforms, Green Party senior official Britta Hasselmann highlighted significant conceptual flaws in the debt plan regarding climate change prevention. The meeting on Thursday is expected to produce a legal draft, with a crucial review scheduled for March 18.

In a report released Wednesday, analysts from Deutsche Bank maintained their view that the reform process is unlikely to proceed smoothly in the coming week, indicating that a compromise proposal would not significantly alter previous estimates of achieving 3%-4% GDP growth through fiscal stimulus by 2027. Analysts also considered the possibility of a split in fiscal proposals, where defense and debt brake policies might pass immediately, while infrastructure plans could be delayed under a new parliament, potentially shifting the focus towards social housing.