German economy unexpectedly shrinks, inflation ticks higher

By Maria Martinez

BERLIN (Reuters) -The German economy unexpectedly contracted in the second quarter after skirting a recession at the beginning of the year and July's inflation rose, showing the continuing struggles of the euro zone's biggest economy.

Germany's gross domestic product contracted by 0.1% in the second quarter compared with the previous three-month period, preliminary data from the statistics office showed on Tuesday.

Analysts polled by Reuters had forecast a 0.1% quarter-on-quarter increase in adjusted terms, following 0.2% economic growth in the first quarter.

Germany was the worst performing major economy last year, with gross domestic product contracting by 0.3%, and it came close to recession at the start of 2024 - buffeted by a combination of cyclical and structural headwinds.

In the second quarter, Germany was a laggard among its peers again, and the divergence in terms of growth has widened: While the German economy contracted, France and Spain did better than expected and Italy held its ground.

The euro zone's economy grew 0.3% in the three months to June, data showed on Tuesday.

"While German data is stagflationary, the eurozone as a whole provides a picture of a relatively solid but potentially fading recovery with sticky inflation," said Carsten Brzeski, global head of macro at ING.

Also countering expectations, German inflation rose in July to 2.6%, preliminary data from the federal statistics office showed on Tuesday.

Analysts polled by Reuters had forecast no change to the inflation rate, after consumer prices rose by 2.5% on the year in June, based on data harmonised to compare with other European Union countries.

Euro zone inflation figures due on Wednesday will shed light on the case for a rate cut by the European Central Bank in September, with the market expecting one more cut by year-end.

In Germany, inflation looks stuck above 2%, analysts say.

"It is this stickiness of inflation that will strengthen the doubts around another rate cut at the September meeting," Brzeski said.

Core inflation, which excludes volatile food and energy prices, was at 2.9% in July, unchanged from the previous month.

This is primarily due to the continued strong inflation in services, which remained unchanged at 3.9% in July, as prices are still pushed up by high wage increases.

"This is unlikely to change much for the time being, meaning that the core inflation rate will remain well above the ECB's target of 2% in the coming months," Commerzbank's senior economist Ralph Solveen said.

Capital Economics said it still expects another rate cut in the September meeting.

"But it looks likely to be a close call and will depend on the August inflation data," said the research firm's chief European economist, Andrew Kenningham.

(Reporting by Rachel More and Maria Martinez;Editing by Kirsti Knolle, Bernadette Baum and Helen Popper)