German business confidence defied expectations in May, inching upward despite the ongoing disruption to global energy markets caused by the Iran war. The ifo Business Climate Index, a closely watched early indicator compiled by the Munich-based ifo Institute for Economic Research, rose to 84.9 points from 84.5 in April.
Economists had forecast a slight deterioration, as higher energy prices and geopolitical uncertainty continue to weigh on Europe's industrial sector. The survey, based on responses from approximately 9,000 companies, showed improved assessments of both current conditions and future expectations across manufacturing, services, and trade. Construction was the only sector to report a decline in sentiment.
Fragile stabilisation amid geopolitical headwinds
“The German economy is stabilising for the time being, although the situation remains fragile,” said Clemens Fuest, president of the ifo Institute, in a statement accompanying the data release. The index remains close to levels seen at the end of 2024 and well below its long-term average, underscoring the persistent weakness in Europe's largest economy.
Germany has been grappling with a prolonged period of industrial weakness and sluggish domestic demand. Increased government spending on defence and infrastructure, part of Berlin's broader effort to revive growth, may be helping to offset some of the strain. The country's fiscal response has been a topic of debate in Brussels, with EU policymakers considering limited fiscal flexibility to support member states facing energy-related pressures.
Jens-Oliver Niklasch, an analyst at the German bank LBBW, described the figures as a “small positive surprise.” He noted that many firms still have solid order books, which could support activity if external pressures begin to ease.
Energy costs and trade routes under pressure
Concerns over shipping through the Strait of Hormuz, a critical chokepoint for global oil and gas supplies, have pushed up energy costs and added pressure on Germany's manufacturing sector, which remains heavily dependent on industrial energy consumption. The Iran conflict has exacerbated volatility in energy markets, with oil prices staying elevated. European markets have shown some resilience amid tentative diplomatic signals, but the risk of further disruption remains high.
Germany's Federal Statistical Office confirmed that the economy grew by 0.3% in the first quarter compared with the previous three months, in line with preliminary estimates. The expansion was supported mainly by stronger exports, which helped the country avoid a renewed contraction after narrowly skirting recession in recent quarters.
However, economists continue to warn that geopolitical tensions, volatile energy markets, and weak global demand could still undermine growth later in the year. The European Commission's executive vice-president for the economy, Valdis Dombrovskis, has reiterated that there will be no easing of Russia sanctions despite inflation pressures, adding another layer of complexity to the energy landscape.
For now, the modest improvement in business morale offers a cautious note of optimism. But with the ifo index still at historically low levels and external risks mounting, the path ahead for Germany's economy remains uncertain.
