(Bloomberg) -- Germany’s economy will probably shrink this quarter and officials must address a range of deep-seated challenges to the country’s business model if they’re to boost the longer-term outlook, according to the Bundesbank.

Despite slowing inflation, robust wage growth and a solid labor market, consumers are hesitant to spend, the central bank said. Meanwhile, manufacturing weakness is intensifying and higher financing costs may be worsening strains on domestic and foreign demand.

While businesses have digested recent headwinds like the energy shock relatively well and there are no signs of the manufacturing sector’s imminent demise, “there’s a broad need for action” to adapt to the new environment, the Bundesbank said. 

“The problems that need to be addressed are complex and partly linked to each other,” it said Monday in its monthly report. Politicians in Berlin are “taking some steps in the right direction. But these also have to be executed and continued.” 

The rapid shift away from Russian fossil fuels, fragmentations in global trade and an aging society have sparked a debate about whether Germany is again facing a period of economic underperformance. Some have evoked the era after reunification in the 1990s when the country was labeled the “sick man of Europe.” 

But Bundesbank President Joachim Nagel has dismissed that analysis, warning not to underestimate the economy’s “adaption capacity.” 

The challenges for the nation are seen as especially pronounced because, at about 18%, manufacturing accounts for a bigger share of gross domestic product than elsewhere. A shift down to levels closer to those of other advanced economies, though, shouldn’t be cause for concern in itself, according to the Bundesbank.

That’s because productivity growth in Germany since the 1990s didn’t exceed that of nations that transitioned to a services-based economy more rapidly. In future, “it will be crucial to make greater use of the potential of digital change,” it said. 

As geopolitical risks grow, businesses should “rethink” their strong reliance on Chinese imports as well as any further investments there, the Bundesbank said. While cautioning that some products companies rely on are hard to source elsewhere, a sudden disentanglement of supply chains would weigh on manufacturing in the short term.

To tackle higher energy costs caused by the war in Ukraine and the green transition, Germany should ensure that renewable power sources and networks can be built quickly, the Bundesbank said, urged simpler and speedier public-planning and approval procedures.

Demographic change presents another key challenge as it’s about to curtail the supply of workers, it said, suggesting officials boost immigration from outside the European Union and provide more childcare to allow women, particularly, to work more. 

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