FRANKFURT (Nov 22): Germany's economy is facing deep and profound challenges that could push up corporate insolvencies, keeping default risk elevated next year, the Bundesbank said in a Financial Stability Report on Thursday.

Germany's economy has been skirting a recession for most of the past year as weak export demand, surging energy costs and rising wages are compressing corporate margins, pushing the country's vast industrial sector deep into recession.

"The German economy is still facing profound structural challenges that are weighing on the medium-term growth outlook," the Bundesbank said.

This will likely shake out the corporate sector, especially since aggregate earnings have declined in almost every quarter since the end of 2022, the central bank said.

"A significant number of corporate insolvencies are likely next year given ongoing structural change and the continued economic weakness," the Bundesbank said. "Default risk for non-financial corporations is likely to remain elevated in 2025... given ongoing structural change and the continued economic weakness."

Insolvencies may be exacerbated by higher interest rates since refinancing needs will increase costs and could contribute to more defaults.

But household finances should remain sound since the labour market is robust and nominal wages are still rising, giving ordinary consumers a healthy financial buffer, the bank added.

Residential real estate prices have also stabilised and while properties are still somewhat overvalued, models suggest that the probability of sudden price drops have declined.

The outlook for commercial real estate is not as rosy, however.

"Commercial real estate prices did not fall any further in the first half of 2024, but the risk of additional significant drops in prices has increased compared with last year," the Bundesbank added.

Uploaded by Siow Chen Ming