Ukraine crisis: impacts on Germany’s economy

At this early stage, the clearest near-term economic implications of Russia’s invasion of Ukraine for the German economy are higher inflation, higher fiscal spending, manufacturing sector disruption, lower economic growth and potential weakened banking sector revenue. Risks to financial sector stability remain, for now, low.

Inflation will be higher for longer. Headline inflation rose to a provisional 5.1% year on year in February, close to a 30‑year high, before any significant market impact from the invasion. The expectation had been that gradually easing supply-side bottlenecks and base effects would dampen inflation from the second quarter onwards. This is no longer the case. Direct upward pressure on costs of energy and other commodities (such as base metals and wheat), and indirect pass-through price effects on other goods and services, will drive a near-term acceleration in inflation. Upward price pressure will also come from more expansionary fiscal policy (including higher defence spending and energy price-relief measures). Our 2022 inflation forecast is currently 3.9%, but we expect to revise this to at least 5%.

Manufacturing activity in Germany will face further disruption from sustained higher prices of energy, agricultural products and base metals. Aside from coal, oil and natural gas, Russia is a major import market for iron and steel, non-ferrous metals, wood, copper, rubber, fertiliser and aluminium, with Ukraine an important source of animal products and electrical parts for engines. Amid already low stocks, prices of aluminium, nickel and palladium—all major components of electric vehicle production—have risen sharply. Since late February Volkswagen has temporarily halted production at two of its main automotive plants, in Zwickau and Dresden, having been unable to secure electrical cabling imports from Ukraine.  

Sanctions imposed by the West on Russia are significant, including the freezing of assets held by its central bank, government and major financial institutions. Direct exposure of Germany’s banking sector to Russia and Ukraine is modest: European banks with the largest exposure are Raiffeisen, UniCredit and Société Générale. Indirect linkages across the wider financial sector could expose pockets of balance-sheet weakness, but risks to credit flows and financial stability appear low. However, the higher-inflation, lower-growth outlook for Germany, will weigh on banking sector revenue and profitability. Global banking stocks have recently fallen quite sharply. 

We will be revising our 2022 forecasts, up for inflation and down for GDP growth (currently 3.2%). We still expect some fiscal consolidation this year, but the government’s target of balancing the budget next year (which we had expected to be met) now seems out of reach.

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