Is Germany facing economic collapse?

Not so long ago, Germany was considered the engine of the EU economy. When things went wrong for other countries in the bloc, there was always the hope that Berlin would come to the rescue.

But now, it seems that the safety net is slowly deflating: the country's industrial production has fallen below 2017 levels, and the threat of recession is more real than ever, although the DAX seems to be holding steady. The pressure on the European Central Bank (ECB) has prompted rate cuts, with potential for further reductions, which could lead to a reversal in the EUR/USD trend even if the Fed cuts rates.

The silver lining for markets is that the European Central Bank (ECB) has repeatedly cut rates, citing Germany's recession risk. The regulator took similar measures in 2001, 2002, and 2011.

So, how did Germany get into this situation?

The problem lies in a business model that depended on cheap energy from Russia, low-cost subcontractors in Eastern Europe, and ever-growing exports to China. Now, all this has disappeared.

Sanctions against Russia and the destruction of the Nord Stream pipelines have driven energy costs through the roof, leaving many companies unable to survive or at least struggling to do so.

The number of German companies heading for insolvency soared in the first half of 2023, reaching its fastest pace in over two decades with 8,400 corporate insolvencies.

Since then, the situation has not improved much: the number of large insolvencies in Germany reached an all-time high in the first six months of 2024, with an increase of 37%, according to Allianz Trade.

The credit insurer forecasts 21,500 bankruptcies of German companies of all sizes for the entire year, an increase of 21% following a similar 22% rise in 2023.

Recently, Volkswagen announced the closure of several factories and the layoff of 15,000 employees, sparking street protests over factors such as over-regulation, inadequate infrastructure, shortage of skilled labor, etc.

It should be noted that the problems are not only due to electricity prices, which remain high compared to a few years ago but also to the high interest rates that the regulator imposed to combat inflation.

Companies are still finding it challenging to repay COVID-19 loans or find new financing, and even with two ECB rate cuts, no miraculous improvement is expected in the coming months.

In addition, deteriorating EU-China relations and the latter's complex economic environment have led to a drastic decline in German exports to Beijing.

In the year's first half, German exporters sent more products to Poland than China. As expected, total exports decreased by 1.6% compared to last year's period.

Where does it lead?

If Germany fails to get back on track and its recent stimulus measures do not help to reduce the number of bankruptcies, the ECB could increase its dovish stance and cut rates further.

In the latter case, the EUR/USD could reverse its trend even with the Fed cutting rates.