According to the latest forecast from the German Economic Institute (IW), amid weakening demand from abroad, soaring interest rates, and an extended energy crisis, Germany will likely see its economic output shrink this year.

According to the IW, the German economy is in a state of “shock,” with geopolitical uncertainties arising from the war in Ukraine particularly affecting German businesses. The institute’s economists warned that due to a combination of scarcity and the surging prices of raw materials and energy, German firms will “feel the global problems all the harder” this year.

The institute predicts that EU’s largest economy will see its gross domestic product come in lower than expected as global trade slows, and demand weakens. Economists with the institute predict GDP will fall by almost 0.5% compared to the previous year, as unemployment will rise to 5.5%.

Inflation has remained elevated since the start of the year, and it is predicted to remain at around 6.5%, suppressing consumer spending.

Professor Michael Gromling, the head of the macroeconomic and the Business Cycle Research Unit at the IW, said, “The government urgently needs to take action to end this economic downturn.”

He added, “Lower tax burdens and attractive and un-bureaucratic support for innovation and investment would help companies cope better with the current shocks.”

As energy prices surged following the Russian invasion of Ukraine, production costs soared, leading to price growth, at which point Germany’s central bank was forced to begin raising interest rates. This has led many companies to begin moving production overseas to locations with lower energy costs and less inflation.

In addition, companies now find investments less attractive, with the worst hit sector the construction field. This year it is forecast that investments in home-building will fall by 3%.