Iran war pushes Germany’s deficit to 4.2% as growth outlook is cut by 50%.

The Iran war is hitting the German economy at the worst possible time. Having only just fought its way out of a multi-year downturn, Europe’s largest economy is now facing a new external shock — and the picture painted by leading researchers is one of structural exhaustion. The country’s top economic research institutes have more than halved their growth forecasts for 2026 in their Spring 2026 Joint Economic Forecast, published Wednesday. The report, compiled twice a year on behalf of the Federal Ministry for Economic Affairs, draws on contributions from the German Institute for Economic Research (DIW Berlin), the Ifo Institute and the Kiel Institute for the World Economy, among others.

Iran war halves growth forecast

Where economists were still projecting growth of 1.3% to 1.4% last autumn, the institute now expects GDP to expand by just 0.6% this year and 0.9% in 2027. Economic output effectively stalled in the first quarter, with the Bundesbank’s March monthly report finding that real GDP likely stagnated on a seasonally adjusted basis in the first three months of the year. “The energy price shock in the wake of the Iran war is hitting the recovery hard, but expansive fiscal policy is supporting the domestic economy and preventing a more severe downturn,” said Timo Wollmershäuser, head of economic research at the ifo Institute. Blocked shipping routes and disrupted energy markets are pushing up commodity and energy prices worldwide, with direct consequences for Germany’s energy-intensive industry.

Inflation on the rise

The price increases are feeding through to consumers. The institutes expect average annual inflation to reach 2.8% in 2026 and 2.9% in 2027. The Bundesbank warns the rate could climb sharply towards 3% in the near term, driven primarily by higher fuel and heating oil prices. Should the Strait of Hormuz — the central artery for global oil and LNG trade — remain blocked, upside risks to inflation could be greater still, directly weighing on private consumption that was supposed to anchor the domestic recovery. While parts of the defence industry and civil engineering are benefiting from government spending, industry as a whole remains sluggish. Exports are barely growing, held back by weak competitiveness, geopolitical uncertainty and trade policy headwinds. The Bundesbank notes that low capacity utilisation is compounding the problem. The chemical sector is bearing the sharpest pain. The Hormuz blockade is disrupting supply chains for raw materials that have no short-term substitutes.

Public debt rises to 67.2% of GDP

The German government is countering the economic headwinds with a sharp increase in public spending. New borrowing for defence, infrastructure and climate protection will push the public deficit to 3.7% of GDP in 2026 and 4.2% in 2027, lifting gross debt to 67.2% of GDP. The institutes see the fiscal boost as an important economic driver but warn that long-term risks to public finances are considerable, with significant consolidation likely needed towards the end of the decade. For Reiche, the findings sharpen the case for reform. “The message of the research institutes’ spring diagnosis is clear: the conflict in the Middle East is increasing the pressure on German politicians to consistently tackle structural reforms,” she said, calling for “courageous reforms”.

Public debt rises to 67.2% of GDP

The German government is countering the economic headwinds with a sharp increase in public spending. New borrowing for defence, infrastructure and climate protection will push the public deficit to 3.7% of GDP in 2026 and 4.2% in 2027, lifting gross debt to 67.2% of GDP. The institutes see the fiscal boost as an important economic driver but warn that long-term risks to public finances are considerable, with significant consolidation likely needed towards the end of the decade. For Reiche, the findings sharpen the case for reform. “The message of the research institutes’ spring diagnosis is clear: the conflict in the Middle East is increasing the pressure on German politicians to consistently tackle structural reforms,” she said, calling for “courageous reforms”. Source: Euronews