Germany’s economy is under considerable pressure, with high energy costs as a result of the Ukraine war, weakening demand from China, and increasing competitive pressure from Asian goods.
After two consecutive years of stagnation and recession, a third year without an upturn is looming in 2025. New tariffs on important German export goods could now be on the cards, threatened by US President Donald Trump. Around 10.4% of all German exports went to the US in 2024, and 13% for passenger cars.
Although the US government has suspended some of the “reciprocal” tariffs announced on April 2 for 90 days, the 25% tariff on German cars is still in force. New duties are also being discussed for the pharmaceutical industry, while a minimum duty of 10% is being imposed on all other products.
The German Bundestag is expected to elect Friedrich Merz as the new Federal Chancellor at the beginning of May. This will leave around two months before the suspension of the increased tariffs ordered by Trump ends.
When Will the German Economy Grow Again?
The German economy got off to a very slow start in 2025. According to initial estimates, gross domestic product stagnated in the first quarter of the year. A slight decline is expected in the second quarter.
“Against the backdrop of the global trade crisis and the turbulence of financial markets, a decline in economic output can hardly be avoided,” writes Deutsche Bank in a research note.
Full-year GDP forecasts for 2025 range from a 0.1% decline, according to think tank and research institute RWI, to growth of 0.4%, according to the OECD. The German government recently lowered its forecast for 2025 once again, from 0.3% in January to 0%. This means that the German economy will stagnate for the third year in a row, as Robert Habeck, acting minister of economic affairs, said on April 24: “The German economy, which is open to trade and already suffers from weak foreign demand and reduced competitiveness, is particularly affected by US trade policy.”
The leading German economic institutes significantly lowered their joint forecast at the beginning of April: from the original 0.8% to just 0.1%. Nevertheless, most institutions expect a moderate recovery of between 0.8% and 1.5% for 2026.
“The geopolitical tensions and the protectionist trade policy of the US are exacerbating the already tense economic situation in Germany,” says Torsten Schmidt, head of economic research at RWI.
“In addition, German companies are facing increased international competition—especially from China. Last but not least, structural weaknesses such as the shortage of skilled workers and high bureaucratic hurdles are weighing on growth.”
Deutsche Bank writes in a research note: “The global trade conflict is increasing the time pressure on the new German government to emerge from its (slightly restrictive) provisional budget management and provide urgently needed fiscal stimulus.”
According to Robin Winkler, chief economist for Germany, and Marc Schattenberg, senior economist at Deutsche Bank, although measures such as the industrial electricity price or increased depreciation rules for investments are helpful, they alone are not enough to cushion the tariff shock.
Government Plans Infrastructure and Defense Spending
The new government is planning an extensive investment program, which is to be financed by a special fund newly anchored in the German Basic Law. It includes spending on defense, infrastructure, and climate protection. However, implementation is likely to take time.
“Especially at the beginning, a lot of money will probably be spent on replenishing depleted stocks and some material will be ordered from abroad,” says Vincenzo Vedda, chief strategist at DWS Group.
Infrastructure investments are considered to be particularly effective for the economy as they have a “fiscal multiplier of one” according to DWS. However, planning procedures and slow implementation are slowing down the effect. In their spring 2025 forecast, the leading German economic institute expects additional government spending to stimulate growth by around 0.5 percentage points.
At the same time, they warn: “Germany is not only suffering from a weak economy, but above all has structural problems. These issues cannot be solved by simply increasing government spending and making reforms to boost potential all the more urgent. For example, the social system needs to be adapted to demographic change so that nonwage labor costs do not continue to rise sharply.”
“Smaller economic sectors are more likely to benefit from additional spending on defense and infrastructure,” it continues. The problem is that they are already working at full capacity and have little to spare. As a result, prices are likely to continue to rise.
German Stocks in Demand
While the economy is weakening, the capital markets are proving to be quite robust. German stocks were in demand at the start of the year despite the weak economy: In February 2025, German equity funds recorded net inflows again for the first time after nine months of outflows. EUR 1.28 billion flowed into the asset class—the highest figure since 2015.
Until Trump’s tariff policy sent global stock and bond markets on a roller-coaster ride from April 2, the Morningstar Germany Index reached several record highs.
According to data from Morningstar Direct, it was primarily financial and industrial stocks that contributed to the gains this year. Allianz ALV and Müncher Rück MUV2 have gained 10.1% and 14.6%, respectively, since the beginning of the year. Right at the top, however, sits Rheinmetall RHM. The defense company is considered a clear beneficiary of the government’s fiscal packages. Morningstar equity analyst Loredana Muharremi significantly adjusted her fair value estimate in mid-March against the backdrop of rising European and German defense spending—from EUR 1,310 to EUR 2,220 per share. Overall, this stock contributed 2.17 percentage points to the stronger performance of the Morningstar Germany Index in the year to date. Meanwhile, Europe’s largest company by market capitalization, SAP SAP, has lost ground, losing 4.87% so far this year and thus reducing the index performance by 0.81 points.
The recent market correction offers investors the opportunity to buy many stocks at a lower price. Currently, 31 of the 49 German stocks rated by Morningstar analysts are undervalued.
Since the beginning of 2025, among the major European stock markets, only Spain has outperformed Germany. In February, European large-cap blend shares were the second most sought-after asset class among European investors, recording net inflows of EUR 6 billion. This was triggered by an incipient reallocation: many investors shifted their capital away from the overpriced US markets and into European stocks. This was driven by valuation differences and the prospect of fiscal easing in the EU and Germany.
Analysts remain positive about Europe.
“Europe’s resilience and undervaluation relative to the US creates fertile ground for selective quality stocks and dividend strategies,” writes Polar Capital in a research note dated April 16. “Looking ahead, investors should consider increasing their allocation to Europe.”
DWS sees the US stock market as the main victim of US tariff policy, however the turmoil will not spare Europe.
“The high valuation gap in combination with the reform of the German debt brake make European equities interesting in relative terms,” says CIO Vedda.
Upside on the Horizon for European Stocks
In view of the uncertainty, DZ Bank sees the stock markets initially trending sideways in a volatile manner, but is also positive in the medium term.
“Only later in the second half the year should there be room for other influencing factors in the perception of market participants,” write Sören Hettler and Christoph Müller in a DZ Bank blog post on April 11 with a view on planned tax cuts in the US and the first real effects of the European fiscal programs.
“In the course of the brighter sentiment that we expect in the longer term, we see the DAX and the euro Stoxx 50 climbing to 23,000 and 5,400 points, respectively, by the end of 2025. By mid-2026, we see upside potential for both European indexes up to record highs in the 25,000 and 5,900 points range,” it says.
For investors, this means that they need to show staying power. Dan Lefkovitz, strategist at Morningstar Indexes, advises investors not to be driven crazy by the daily back and forth on the stock markets.
“It’s crucial to experience the big up days in the market. That’s why it’s a bad idea to jump in and out of stocks,” he writes. “If you take a wait-and-see approach, your portfolio can benefit from unforeseen upswings.”
Bonds a Safe Haven for Investors
The latest upheavals have also left their mark on the bond markets. Yields on 10-year German government bonds rose sharply until the beginning of March—driven by the expectation of increased new debt as a result of the new fiscal package. Prices, which move in the opposite direction to yields, fell.
“On March 5, German government bonds experienced their darkest day in the history of the eurozone, when the yield on the benchmark 10-year bond shot up by 30 basis points,” says Alessandro Tentori, CIO Europe at AXA Investment Management. “The strong market reaction is related to the fact that Berlin is moving beyond the role of an advocate of orthodox fiscal policy and is using its large fiscal space for structural projects. This could signal a change in economic conditions in Europe ”
However, with the escalation of the trade conflict, another aspect came to the fore at the beginning of April: demand for German government bonds increased because the erratic US tariff policy cast doubt on the status of US government bonds as a safe haven. The high demand caused prices to rise and yields to fall.
“At just over 2.50%, yields on 10-year German government bonds are currently at a level last seen at the beginning of March. At that time, the prospect of a massive increase in debt and easing of the debt brake had contributed to a temporary rise to over 2.90%. Since then, yields have come back with fluctuations,” Helaba said on April 16.
The situation is similar for two-year Bunds, but another aspect comes into play here: the expectation of further and faster interest-rate cuts by the European Central Bank due to the gloomier economic outlook caused by the trade war. These have pushed yields on two-year bonds down by 0.26% since the beginning of March, compared with a fall of 0.15% for 10-year bonds.
“Fixed-income managers believe that Treasury yields are attractive at current levels,” says Evangelia Gkeka, Morningstar senior analyst fixed income.
“With bond issuance likely to increase to fund higher spending, yields are expected to rise somewhat as the scarcity premium eases (more supply of bonds will come to market). In addition, German government bonds remain a good diversifier in a globally oriented portfolio due to their safe-haven characteristics.”
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar's editorial policies.
