- If Europe's biggest economy tips into recession, the rest of the eurozone is likely to suffer.
- The US-China trade war has been a key driver of the decline, as both countries are huge export markets for Germany.
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Germany shrunk by 0.1% in the three months to June . The decline might not seem like much, but given the country is the world's fourth-biggest economy and Europe's largest, a slowdown is a bad omen for global markets.
That's mainly because the eurozone is heavily reliant on a strong German economy. If it's "teetering on the edge of a recession," as Capital Economics Chief European economist Andrew Kenningham said, all eyes should be pointed to Europe's industrial heartland.
Why has Germany been hit so hard by the trade war?
The German economy is much more globalized than the rest of the world, according to Capital Economics. As a result, international trade tensions weigh on its economy.
Germany is particularly dependent on exports, a lot of which pass through non-eurozone economies such as China and the US. It provides a lot of equipment and machinery to China, which in turn makes products that are shipped across the world to destinations including the US.
As a result, if China weakens its currency and produces fewer goods in anticipation of weaker overseas demand, sales of German industrial products fall, damaging a key sector of Germany's economy. Proof of the trade war's impact can be seen in the 1.5% month-on-month decline in German industrial output in June.
All this means that if Germany does head towards a recession, the rest of Europe could go with it, in part because of the trade war.
Is there a chance of a reversal?
It doesn't seem likely that Germany's fortunes will turn around.
There is little chance of a fiscal boost from the German government, mainly because it takes a cautious approach to the economy focused on raising surpluses and lowering debt, according to Capital Economics.
"The federal government recorded a surplus of 1.7% of GDP last year while its debt was close to 60% of GDP and is set to fall to 55% by 2021," the economics research firm said.
As a result, it may fall to the European Central Bank and its president, Mario Draghi, to deliver the stimulus.
"Regardless of which parties form the next federal government, Germany will continue to run small surpluses for the foreseeable future," Capital said in a note.
"The current rules leave room for a small further fiscal stimulus in 2020 or 2021, but probably of less than 0.5% of GDP in total. This would leave the onus on the ECB, which is increasingly short of ammunition, to try to shore up demand and boost inflation."
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