The domestic and foreign policy parameters changed considerably for the German economy in spring 2025. Moreover, unpredictable US trade policy is weighing heavily on macroeconomic growth in Germany, and the security situation in Europe has deteriorated since the new administration took over in Washington. However, the new German government is likely to have access to more headroom for borrowing in order to respond to these challenges, which provides grounds for optimism. Amendments to legislation that will allow the German government and the federal states to spend more on defense, other security policy matters, climate action, and infrastructure have been passed by both chambers of the German parliament.

The broader economic recovery is likely to be delayed further, mainly due to US tariff policy. Against this backdrop, the economic research institutes contributing to the Joint Economic Forecast have significantly lowered their growth forecast for Germany for 2025. In their 2024 autumn report, the researchers had still forecast growth of 0.8 percent in inflation-adjusted gross domestic product (GDP), whereas their more recent spring report effectively predicts the stagnation of real economic output (growth of 0.1 percent). The expected substantial rise in government spending will invigorate the economy only over a longer forecast horizon. For 2026, the research institutes project inflation-adjusted economic growth of 1.3 percent.

Spending on capital equipment will probably not start to rise again until the second half of 2025, when structural changes in the manufacturing sector are expected to have less of a dampening effect and international business should start to pick up. With regard to construction investment, the ground seems prepared for a trend reversal, but the recovery is likely to take a while. Likewise, the revival of consumer spending will be a slow process. The research institutes predict that consumer prices will rise by 2.1 percent next year, a slightly lower rate than this year (2.2 percent). Unemployment is also expected to edge down, from an average of 6.3 percent for 2025 to an average of 6.2 percent for 2026.

Most major central banks started to loosen their monetary policy in 2024 by lowering interest rates. The ECB continued on a less restrictive policy trajectory in early 2025. At its meeting on April 17, 2025, it not only cut interest rates again, but also confirmed that the disinflation process was progressing well and that inflation was moving in line with the expectations of ECB experts. It anticipates that the medium-term inflation target of 2 percent will be reached. At the same time, the ECB Governing Council emphasized that the current market environment was characterized by heightened uncertainty and reiterated that it would not commit to any specific trajectory for interest rates in advance. Going forward, the council intends to make

data-driven decisions from meeting to meeting, based on analyses of the outlook for inflation, the underlying inflation drivers, and the effectiveness of the monetary policy transmission mechanism.

Although the ECB Governing Council has ruled out committing to specific future interest-rate actions, it emphasized at its meeting in March 2025 that monetary policy in the eurozone has already become significantly less restrictive. It explained that the interest-rate cuts that have been implemented so far have lowered the cost of new borrowing for companies and consumers, and lending growth is gaining traction again. At the same time, because certain effects of interest-rate changes take a long time to materialize, historical interest-rate increases are still affecting existing loans and lending activity remains muted overall. Following the interest-rate cut in April, the reference to the restrictive impact of monetary policy was removed from the monetary policy press statement. Central banks commonly use estimates of the neutral interest-rate level to provide guidance on when the restrictive effect of monetary policy is likely to cease. In a publication from February 2025, the ECB estimated that the neutral interest-rate level was in a range from 1.75 percent to 2.25 percent. This estimate leaves only limited scope for further interest-rate reductions before monetary policy in the eurozone would cross back into expansionary territory.

The aforementioned macroeconomic effects also impact on our outlook for the banking sector in various ways. For instance, the BVR believes that risk costs in the lending business in 2025 will be at least on a par with 2024 due to economic uncertainties in Europe and geopolitical risks. Weaker economic conditions are likely to cause many companies’ resilience to stagnate or even decline, which, in combination with persistently higher funding costs, could adversely affect the servicing of debt. Net interest income in the German banking sector is predicted to hold steady in 2025, partly because the ECB will probably reduce its key interest rates further and partly because interest rates on liability-side products are set to come down in 2025. New lending business should grow more robustly than in 2024. Property prices are not expected to drop further and an increase in average debt service capacity, primarily due to collectively agreed pay rises, should help a new equilibrium to be reached to some extent.

The high risks arising from the geopolitical and macroeconomic environment will have a marked influence on the results for 2025. Net interest income is expected to be on a par with 2024. Net fee and commission income should grow modestly year on year. These two components will be the main factors for earnings. The bulk of fees and commissions will continue to be generated from payments processing and the brokerage of investment products.

There will be a further net gain under gains and losses on investments in 2025 thanks to expected reversals of impairment losses on investments, although the net gain will be significantly smaller than in 2024. We still do not anticipate any material credit-quality-related risks in connection with investments. In light of the extended period of economic weakness in Germany and global geopolitical risks, expenses for loss allowances are forecast to fall in 2025 but will remain significantly above the levels of previous years. This is because loan defaults in the customer business, especially among corporate customers, are still expected to rise. Net income from insurance business is predicted to decrease noticeably in 2025, primarily owing to a marked increase in expenses in the insurance business. In addition, a moderate rise in administrative expenses is forecast for 2025 in connection with collectively negotiated pay increases.

Taking account of the factors described above, profit before taxes is expected to be lower in 2025 than in 2024.

The regulatory capital ratios will fall in 2025 as the growth of the customer lending business and CRR III transition effects will lead to a rise in risk-weighted assets that probably cannot be fully offset through retention of profits.