German Economy Shows Signs of Recovery as 2026 Begins

Q4 2025 GDP Growth Signals Positive Shift

Germany's economy concluded 2025 on a more positive note, with its Gross Domestic Product (GDP) expanding by 0.3% quarter-on-quarter in the fourth quarter of 2025. This modest expansion, confirmed by preliminary and revised estimates from the Federal Statistical Office (Destatis), marked a rebound from stagnation in the previous quarter and contributed to an overall annual growth of 0.2% for 2025, or 0.3% when calendar-adjusted. This follows a 0.5% contraction in 2024, indicating a shift away from recent economic challenges.

The primary drivers behind this improved performance were robust domestic demand, notably an increase in household consumption and government spending. Additionally, a resurgence in construction and equipment investment played a significant role in bolstering economic activity during the final months of the year.

Inflation Aligns with ECB Target

A key development for the German economy has been the return of inflation to the European Central Bank's (ECB) target. After registering an annual inflation rate of 2.1% in January 2026, the rate eased further to 2.0% in February 2026. This figure precisely matches the ECB's long-standing target for price stability. Core inflation, which excludes volatile food and energy prices, stood at 2.5% in January 2026. This deceleration in price growth suggests that inflationary pressures are becoming more contained.

Mixed Signals in Business Sentiment

Business sentiment in Germany has presented a nuanced picture as the country transitioned into 2026. The Ifo Business Climate Index, a closely watched indicator, initially saw a decline in December 2025, falling to 87.6. At that time, companies expressed increased pessimism regarding the outlook for the first half of 2026, with Ifo President Clemens Fuest noting that the year was 'ending without any sense of optimism'.

However, more recent data indicates a tentative recovery in confidence. The Ifo Business Climate Index rose to 88.6 in February 2026 from 87.6 in January, suggesting improving sentiment. Fuest later remarked that stronger domestic demand and fiscal stimulus are now supporting the economy. Despite this uptick, a survey by the German Chamber of Industry and Commerce (DIHK) in early 2026 revealed that only a quarter of companies rated their current business situation as good, and one in four anticipated a deterioration in 2026, highlighting persistent caution among businesses.

Outlook for 2026: Modest Growth Expected

Looking ahead, the German government has adjusted its growth forecast for 2026, trimming it to 1.0% from an earlier projection of 1.3%. Despite this revision, the forecast still represents a significant improvement over the 2025 performance. Goldman Sachs Research also projects a 1.1% growth for Germany in 2026, largely attributing this to expansionary fiscal policy designed to boost domestic demand.

While risks of contraction are fading, the recovery is expected to be modest. Challenges such as weak domestic demand, high operating costs, geopolitical uncertainties, and a softening labor market continue to be factors influencing the economic landscape. Fiscal stimulus measures are anticipated to play a crucial role in supporting growth throughout the year.