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(Bloomberg) — Germany’s economic prospects are looking up after two grueling years of near-zero growth. The consumer-led revival, though, papers over enduring industrial weakness for which there’s no quick fix.

Data this week signaled the fledgling recovery in Europe’s largest economy is gaining momentum — especially in service sectors like tourism and hospitality. The mood among businesses is perking up as confidence builds that a widely anticipated winter recession has, in fact, been avoided.

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Even as factories remain mired in a slump, the green shoots are being welcomed across the 20-nation euro zone, where Germany was the primary engine of expansion before surging energy costs and wilting Chinese demand turned it into the biggest laggard.

Politics may also benefit as rising wages, retreating inflation and the likelihood of imminent cuts in interest rates boost the outlook — helping blunt the appeal of the far-right AfD party whose support has surged in recent years.

“Consumers are a bit more certain about developments and are happy to spend a bit more,” said Anja Heimann, an economist at HSBC. But with manufacturing still on the back foot, “we don’t really expect a strong pickup in Germany, because industry has such an important weight in overall growth.”

An initial verdict on first-quarter gross domestic product is due Tuesday from Destatis, with the Bundesbank recently reversing an earlier call for contraction to now predict growth, albeit modest. On the back of shrinking output in the previous period, rising industrial production and a better performance by construction amid mild winter weather probably buoyed the result.

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That view chimes with economists surveyed by Bloomberg, who estimate a 0.1% advance in GDP. A Bloomberg Economics nowcast, though, still points to a slight dip.

What Bloomberg Economics Says…

“The German economy is on the road to recovery, according to recent survey data. The stronger April reading of the Ifo business climate index points to higher-than-expected activity in the current quarter, mainly driven by accelerating growth in the services sector.”

—Martin Ademmer, economist. Click here to read the full note

Whatever the outcome, there’s a good chance this quarter will be stronger. Business expectations measured by the Ifo institute hit a one-year high in April, while consumer sentiment gained for a third month thanks to rising pay expectations, according to GfK.

The renewed belief comes against a backdrop of moderating inflation, which has slowed to 2.3% from a peak of 11.6%. That trend is mirrored across the region, prompting the European Central Bank to pencil in a first rate cut for June following its barrage of hikes.

Companies reporting first-quarter results this week began to reflect the better news: Software maker SAP SE foresees record revenue growth in its cloud business, while Adidas AG boosted its profit target. 

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Tempering the scale of Germany’s rebound, however, is its outsized manufacturing sector, whose malaise is now approaching two years, according to S&P Global’s latest poll of purchasing managers.

Chemicals giant BASF SE saw earnings decline at the start of 2024, with Chief Executive Officer Martin Brudermueller saying he can’t “confirm a fundamental turnaround” in his industry, which has been weighed down by higher gas prices and limp foreign demand.

The mood in the flagship auto sector isn’t much better. Supplier Continental AG fell short of already low expectations, and CEO Nikolai Setzer warned shareholders Friday of a “sluggish start to the year.” 

Some are optimistic that manufacturers will eventually catch up with other parts of the economy.

Bundesbank President Joachim Nagel said he’s hearing of “relatively robust” factory orders, while Deutsche Bank AG analysts are bullish that global growth will support exports in the coming months. The International Monetary Fund recently lifted its projection for world output in 2024 by a touch, to 3.2%. 

Chancellor Olaf Scholz has also struck an optimistic tone, saying “the contribution of German industry to growth, prosperity and employment remains unbroken.”

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While it will take time for manufacturers to feel the benefits of looser monetary policy, exports could benefit from firmer global trade this year. Indeed, Ifo President Clemens Fuest is puzzled it’s not happening already.

“We see an improving worldwide economy, but this doesn’t seem to reach German manufacturing,” he told Bloomberg TV’s Francine Lacqua. “We don’t see the recovery there yet. It will hopefully be coming but that may take some time.”

Structural worries also loom large. Lowly longer-term GDP forecasts worried Economy Minister Robert Habeck when he presented a meager upgrade to this year’s projection on Wednesday. The government now sees growth of 0.3% — up from 0.2% before.

“We must enable new economic dynamism, strengthen innovation, reduce unnecessary bureaucracy and tackle labor shortages with determination,” Habeck said. 

That’s proved difficult. A recent €3.2 billion ($3.4 billion) tax-relief package was diluted during lengthy negotiations and deemed by Finance Minister Christian Lindner as only a first step toward more rapid economic expansion.

What’s more, Scholz’s three-party coalition will need to find about €20 billion in savings for next year’s budget to comply with constitutional borrowing limits. But while the resulting debate may restrain the economic upswing, it won’t prevent it, according to Holger Schmieding, chief economist at Berenberg. 

“As long as policy uncertainty doesn’t get worse, households and businesses are likely to step up spending from the recent depressed levels,” he said. “The rebound in business and consumer expectations points that way.”

—With assistance from Ben Sills and Kamil Kowalcze.

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