Germany‘s economic outlook has become increasingly cautious as fears of a potential second consecutive year of recession, coupled with the uncertainty surrounding new US trade policies, dampen sentiment. The ZEW Economic Sentiment Index for Germany dropped significantly in January, highlighting growing concerns about weak private consumption and inflationary pressures.

Economic Sentiment in Germany Takes a Hit

The ZEW Economic Sentiment Index for Germany fell to 10.3 points in January, down from 15.7 in December, and missing market expectations of 15.3. While the decline isn’t a complete collapse, it underscores the ongoing challenges faced by the German economy, particularly in sectors like private consumption, construction, and inflation.

However, there was a slight improvement in the assessment of Germany’s current economic situation. The sub-index rose by 2.7 points to -90.4, suggesting that conditions, while still negative, haven’t worsened as much as feared. Despite the decline in sentiment within Germany, the broader eurozone remained more optimistic. The ZEW Economic Sentiment Index for the eurozone rose by 1.0 point to 18.0, signaling relative resilience in the region.

Recession Fears and Political Uncertainty

ZEW President Achim Wambach linked the decline in sentiment to Germany’s economic stagnation and rising geopolitical risks. The expectation of a second consecutive year of recession has led to a more negative economic outlook, exacerbated by weak GDP growth and inflationary pressure.

Political uncertainty, both domestically and internationally, is further complicating the situation. Germany’s upcoming snap election, after the collapse of Chancellor Olaf Scholz’s three-party coalition, has added to the political instability. Polls show the centre-right CDU/CSU in the lead, followed by the far-right AfD, with other parties such as the SPD and Greens trailing behind. This uncertain political landscape adds to market caution.

On the international front, the economic outlook is clouded by the new US administration’s unpredictable trade policies. Although US President Donald Trump refrained from implementing new tariffs in his initial executive orders, his establishment of an “External Revenue Service” to oversee tariff collection has raised concerns about a more protectionist approach in the near future. Trump’s campaign promises to impose tariffs of up to 10% or 20% on imports, including from Europe, have added to fears of trade disruptions.

Markets React Cautiously

European markets showed little movement in response to Trump’s first policy actions. The DAX index remained flat at 20,990 points, close to record highs. While some stocks, such as Sartorius, Siemens Healthineers, and Rheinmetall, saw modest gains, others like Commerzbank, Fresenius Medical Care, and RWE declined.

The euro fell by 0.6% to 1.0357 against the dollar, after a brief relief rally following the absence of immediate tariff measures in Trump’s initial executive orders. As investors anticipate potential rate cuts from the European Central Bank, the euro could face further pressure in the coming weeks.