Germany's business climate hits near four-year low as 2025 outlook darkens

Germany's business confidence has plunged to its lowest level since mid-2020, with firms signalling deteriorating expectations for the coming year.

The ifo Business Climate Index fell to 84.7 points in December 2024, down from a downwardly revised 85.6 points in November, and below analysts' expectations of 85.6 points. This marks the weakest reading since May 2020, when pandemic-induced restrictions severely impacted German businesses.

The decline was evident across the manufacturing, services, and trade sectors, where future expectations turned increasingly pessimistic. In contrast, the construction sector showed slight improvement from previously depressed levels in its current assessment, though its outlook for the future remained downbeat.

"The decline was due in particular to more pessimistic expectations. By contrast, companies assessed the current situation as better. The weakness of the German economy has become chronic," noted Clemens Fuest, President of the ifo Institute.

Breaking down the data, the subindex for current business conditions saw a slight improvement, rising from 84.3 points to 85.1 points, surpassing consensus estimates of 84 points.

However, the expectations sub index, which measures the sentiment on the outlook for the months ahead, dropped sharply to 84.4 points, down from November's revised 87 points, marking its lowest level since February 2024 and falling well short of the anticipated 87.5 points.

Pessimism grips the German economy

Sentiment varied across sectors but remained overwhelmingly bleak. "No sector is really optimistic about 2025. A lot of work awaits the new German government,” said Klaus Wohlrabe, an ifo expert.

In the construction industry, a majority of firms (51.5%) expect a worsening business situation in 2025, while fewer than 5% foresee any improvement. 

Retailers echoed this pessimism, with 42.1% anticipating further deterioration and only 7.9% expressing optimism. Half of the surveyed retail companies expect conditions to remain unchanged.

In services, optimism is slightly stronger, but still muted: 11.9% of businesses expect better conditions, while 28.2% foresee decline. Most service providers (59.9%) expect no change.

In the manufacturing sector, companies appear equally downbeat. While 15.7% of firms expect an improvement, 31.8% anticipate a further decline. The majority (52.6%) predict no significant changes.

Ifo highlights "creeping de-industralisation" risks

Structural challenges, not just cyclical weakness, are at the heart of Germany's gloom. Export-reliant manufacturing is suffering from a loss of competitiveness, especially outside Europe. 

Lara Zarges, an ifo economic expert, said: "Due to structural location problems and high levels of uncertainty regarding the economic policy framework, companies are holding back on their investments."

For some economists, this stagnation raises a red flag. "At the moment, it is not yet clear whether the current phase of stagnation is a temporary weakness or one that is permanent and hence a painful change in the economy,” said Timo Wollmershäuser, deputy director of the ifo Center for Macroeconomics and Surveys.

Last week, ifo slashed its growth forecasts, predicting that Germany's economy will contract by 0.1% in 2024 after shrinking 0.3% this year. A slight rebound to 0.4% growth is expected in 2025, with growth reaching 0.8% by 2026.

 The long-term picture, however, raises concerns about "creeping deindustrialisation". In its baseline scenario, ifo institute predicts that the share of manufacturing in Germany’s total gross value added will decline, with companies relocating production and investments abroad. 

Productivity growth remains weak, as industrial output gives way to less productive services.

Market reactions: Euro weakens, bund yields fall

The deteriorating economic outlook weighed on German financial markets. The euro weakened on Tuesday, with the EUR/USD exchange rate slipping 0.3% to trade below 1.05.

German sovereign bonds benefitted from increased investor demand, pushing yields on 10-year Bunds down to 2.22%.

Equities remained largely flat, with the DAX index showing little movement after a 0.4% drop the previous day. Among the top performers were Airbus SE, Siemens AG, and BMW AG, which rose 1.5%, 1%, and 0.9%, respectively. In contrast, Deutsche Post AG and Rheinmetall AG were among the day’s biggest laggards, falling 2.2% and 2%, respectively.