One month into the Russia-Ukraine war, the Bundesbank, Germany’s central bank, has warned that the conflict could have devastating effects on the German economy, weakening its economic growth and even potentially ushering Europe’s most industrialized country and its largest economy into a recession.

"The effects of the Russian invasion on Ukraine should noticeably weigh on German activity in March," reads the latest report from the Bundesbank, which assesses a slowing economy just emerging from the effects of the COVID-19 pandemic.

Germany: supply chain crisis, inflation and recession

Bundesbank’s report predicts that Germany’s economic output may fall "noticeably" in the first quarter of 2022, after it fell 0.7% in the fourth quarter of 2021, spooked by another wave of the pandemic and manufacturing activities being hit hard by supply chain bottlenecks. In December 2021, inflation reached 5.3 percent, the highest spike in almost three decades.

On Wednesday, the ifo Institute, a Munich-based economic think tank, cut its economic growth forecast for Germany, expecting the country's gross domestic product (GDP) to only rise between 2.2 percent and 3.1 percent in 2022.

The Russia-Ukraine crisis is "curtailing economic growth and accelerating inflation in Germany," observed the ifo Institute. German economists have already predicted an economic downturn between January and March, which would push Germany into a technical recession after witnessing economic contraction in the last quarter of 2021. A second straight quarter of negative economic growth (two consecutive quarters of negative GDP growth) meets the working definition of a recession.

European Union (EU) considers Russian oil ban, Germany differs

Another scenario is emerging that may add to the woes of Germany, the world’s fourth-largest economy. Despite the EU’s reliance on Russian natural gas, the EU is considering joining the US ban on importing Russian energy due to its invasion of Ukraine. The EU debated and disagreed on Monday on whether to join the US in sanctioning Russian energy imports ahead of talks with US President Joe Biden scheduled for today in Brussels.

Within the EU, there is dissent on banning Russian oil imports. The Baltic countries, less dependent on Russian energy, are urging the EU to impose an oil embargo. Germany differs.

Germany’s dependance on Russian oil imports

According to data collated by Anadolu Agency, the EU has imported nearly US $18.7 billion (€17 billion) worth of natural gas, oil and coal from Russia since the beginning of the war in Ukraine. In 2021, the EU bought 155 billion cubic meters of Russian gas, as per the International Energy Agency (IEA).

“About half of German imports of gas and hard coal, and about one third of its oil imports originate from Russia,” wrote Benjamin Moll, Professor of Economics at the London School of Economics and Political Science (LSE) in his recent blog.

An immediate ban on Russian energy imports would trigger an economic recession in Germany and across Europe, German Chancellor Olaf Scholz warned Wednesday, as was reported in Politico.

Addressing Germany’s parliament, Bundestag, Scholz noted Germany would end its energy dependence on Russia in due course, but cutting all ties now would hit the German economy unprepared.

"We will end this dependence on Russian oil, coal and gas as quickly as we can, but to do that immediately would mean plunging our country and all of Europe into a recession," the chancellor remarked, warning that "hundreds of thousands of jobs would be at risk, entire industries would be on the brink" as was published in Politico on Wednesday.

But Scholz said the process of moving away from Russian energy dependence has already started. Germany is diversifying its supply sources of gas, oil and coal in the coming months and has pledged to accelerate the construction of liquid natural gas (LNG) terminals on its northern coast, which would make the country less dependent on supplies from Russia.

The Germans are stepping up efforts to wean themselves of their dependence on Russian energy, but it will mean an uncomfortable and expensive few years or more for its industrialized economy. In the meantime, a complete freeze of Russian imports by the EU would squeeze Russia, but it would also mean collateral damage for the EU, particularly for Germany because finding energy import replacements instantly is an impossible task and also because more time is needed to adapt the country’s energy infrastructure.

Should the US and its western allies impose fresh sanctions on Russia, or the EU ban Russian energy, it may result in a response from Russia – they may cut energy supplies to Europe. And if that happens, it is likely to drive oil prices higher as global supply constricts without Russian oil.

Surging oil prices invariably lead to soaring inflation. This will likely shove countries across Europe, Germany included, into a recession.

The loss of Russian energy exports since the start of the Ukraine war has already led to the sixth-largest disruption in the supply of oil since World War II, as per analysts at Goldman Sachs. In addition, should Russia dramatically escalate the conflict in Ukraine, it may compound or aggravate supply shortages to Germany, which is dependent on Russia to heat its homes and fuel its factories.

Conclusion

Germans should brace for higher prices as Russia’s invasion of Ukraine disrupts trade and makes oil as well as wheat more expensive (on Wednesday, oil jumped above $120 a barrel), the Bundesbank said on Monday.

Germany’s reliance on Russian gas, oil and hard coal, along with wheat exports from Ukraine and Russia, has darkened its economic outlook. Even as the EU is split on Russian oil sanctions – experiencing deep discomfort about handing cash to Russia for energy payments and with a growing understanding within Germany of ending its Russian reliance through faster adoption of renewable energy production and search for alternative sources of energy – for now there is an increasing possibility of Germany slipping into recession.

“It’s not yet possible at the present time to reliably estimate what effects the war will have on economic developments in Germany,” explained Bundesbank President Joachim Nagel. If uncertainty prevails and the inflation outlook warrants it, the Bundesbank may hike interest rates by year-end.