- The German economy, the largest in Europe, has a big industrial sector that's under huge pressure.
- Factory inflation just hit its highest since records began in 1949 as electricity costs soared 600%.
- Germany's addiction to Russian energy is helping to push it towards recession.
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Germany, Europe's largest economy, is struggling with its addiction to Russian energy. It's in the midst of a crippling energy crisis that's prompted inflation to soar and push the country towards recession.
Electricity prices in Germany skyrocketed more than 600% in the year to July on the back of soaring natural gas prices, piling the pressure on businesses and consumers alike.
Producer price inflation — a measure of the prices charged by manufacturers when goods leave their factories, and a leading indicator of consumer price inflation — surged to 37.2% in the year to July, the sharpest rise since records began in 1949, official data showed last week.
The German economy stagnated in the second quarter of 2022 and many forecasters are expecting imminent recession.
Here's what's going on.
Germany has long looked to Russia for oil and natural gas. Even at the height of the Cold War, the Soviet Union sent a reliable supply of energy westwards to Germany.
By 2019, Germany was importing 71% of its energy, with around half its natural gas imports and a third of its oil coming from Russia.
Then, in late February, Russia invaded Ukraine.
As diplomatic relations between Russia and the West soured, Moscow slashed its supply of natural gas through the crucial Nord Stream 1 pipeline to Germany, to just 20% of capacity, sending energy prices soaring.
The European Union's complex energy pricing system means electricity prices have followed suit, hitting record highs on an almost daily basis.
"Germany is more vulnerable than most European countries to higher gas prices," Andrew Kenningham, chief Europe economist at Capital Economics, told Insider. "That in turn is because it has quite a big industrial sector."
The country's large chemicals and metals sectors are heavy users of natural gas and have seen their costs soar as a result. For example, the cost of manufacturing fertilizer in Germany more than doubled in the year to July.
Adding to the energy crisis, heatwaves across Europe have sapped water levels on the Rhine river, disrupting shipping on a crucial transport artery for German factories. Germany's manufacturing sector contracted in June and July, according to preliminary survey data released by S&P Global on Tuesday.
And like all eurozone economies, Germany is grappling with rising interest rates as the European Central Bank tries to tackle soaring inflation.
S&P economist Phil Smith said weakness in manufacturing was being "compounded by a slowdown in the service sector, with surveyed businesses reporting a growing strain on demand from high inflation and increased interest rates."
The German economy flatlined in the second quarter and economists expect things will get worse.
"We've been forecasting recession for a while," Capital Economics' Kenningham said, adding that he expects the German economy to contract in the fourth quarter of 2022 and the first quarter of 2023. "The discussion now is really moving on to: How deep a recession?"
Germany's central bank now expects inflation to rise from 8.5% in July to above 10% — which would be the highest level since the early 1950s.
A slowdown in Germany's economy is bad news for its European neighbors. Yet analysts say the chance of a full-blown economic and financial crisis rocking the eurozone, on a par with the early-2010s, remains slim.
For one thing, Kenningham said, the ECB is now well-practiced in managing economic slowdowns through emergency measures like bond purchases.
For Germany, though, the future is less rosy. The industrial powerhouse of Europe is sputtering.