Iran Conflict Weakens German Economic Outlook as Business Confidence Falls to Pandemic-Era Low
Introduction
The ongoing conflict in the Middle East, especially the war involving Iran, has significantly weakened economic prospects for Germany, Europe''s largest economy. Recent data show a sharp drop in business confidence, and the federal government has lowered its growth forecasts while raising inflation expectations.
Main Body
The Ifo Institute for Economic Research reported that its business climate index fell to 84.4 in April, down from 86.3 in March. This was the lowest level since May 2020 during the early COVID-19 pandemic. The decline was worse than market expectations, which had predicted 85.7. Both current assessments and forward expectations decreased. Ifo President Clemens Fuest stated that the German economy is being severely affected by the Iran crisis. Klaus Wohlrabe, head of surveys at Ifo, noted that sentiment weakened across all sectors, indicating a loss of confidence. Furthermore, the ZEW Indicator of Economic Sentiment dropped by 16 points to -17.2 in April, its lowest since December 2022, reflecting rapidly deepening pessimism. The Federal Ministry for Economic Affairs and Energy reduced its growth forecast for 2026 from 1.0% to 0.5%, and for 2027 from 1.3% to 0.9%. It raised inflation projections to 2.7% for 2026 and 2.8% for 2027. The ministry attributed the downgrade to higher energy costs and weaker external demand. Economy Minister Katherina Reiche acknowledged that the fuel relief and other measures would not solve the underlying structural issues behind Germany''s weak growth. She emphasized the need for a competitive economy and far-reaching structural reforms. To mitigate the energy price shock—Brent crude prices have risen about 73% year-to-date—the coalition government approved a two-month tax relief on petrol and diesel worth about €1.6 billion. Reiche stated that the government acted quickly to ease rising fuel costs. However, analysts expressed caution. Carsten Brzeski, global head of macro research at ING, noted that the war highlights Germany''s heavy dependence on energy imports and that shifting dependencies from Russia to the Middle East is not a structural solution. He added that higher energy prices are diverting government focus from overdue structural reforms toward short-term support, which he described as an unpromising strategy. Fuest pointed out that the conflict disrupts not only oil and gas supplies but also intermediate products for the chemical and construction industries, posing a risk of bottlenecks that could halt production. Germany remains a major net energy importer, with about 6% of its energy coming from the Middle East, according to ING analysis. Energy-intensive industries, employing nearly one million people, account for roughly 17% of industrial gross value added. Market observers had expected that Germany''s large fiscal stimulus package—including a €500 billion infrastructure fund for transport, digital, and energy, plus increased defense spending beyond the historic 1% of GDP limit—would boost the economy. Fuest stated that the fiscal expansion remains a tailwind and is now even more welcome, noting that without it the German economy would be shrinking. Defense is one sector continuing to grow due to rising orders. Brzeski indicated that the €200 billion-plus earmarked for infrastructure and defense is still on track, but some funds will likely be absorbed by higher energy prices and supply chain frictions, slowing progress. He concluded that the war is painfully delaying the German recovery but not yet derailing it. Niklas Garnadt, German economist at Goldman Sachs, assessed that the growth downgrade does not meaningfully affect spending from the fiscal package. Under a baseline for energy prices, he expects fiscal measures worth about 0.1% of GDP (€4–5 billion) to be directed toward higher energy costs this year and next, but these should not replace the package''s spending. He does not anticipate substantial additional measures beyond the fuel tax break and tax benefits for one-off inflation bonuses (worth about €3 billion), and expects stronger spending in the second half of the year aligned with historical patterns and continued ramp-up of infrastructure and defense outlays. Brzeski further argued that Germany urgently needs a better and more committed energy strategy ensuring more autonomy and competitive prices, whether through renewables or rethinking nuclear, and that the government must finally produce a long-term strategy.
Conclusion
The Iran conflict has caused a serious drop in German economic sentiment and growth expectations, with business confidence falling to levels not seen since the pandemic. While the government''s fiscal stimulus package provides a buffer, higher energy costs and supply chain disruptions are delaying the recovery. Structural reforms and a coherent long-term energy strategy remain critical to addressing the underlying weaknesses exposed by the crisis.