Europe's economy faces a 'bumpy' ride in 2025. What are the 5 main areas of focus?
Between political turmoil, some weak economic data and warnings about its lack of growth potential, Europe had a difficult year. However, amid a bleak outlook, analysts say there may be some bright spots to see in 2025. Economic growth in Europe is not expected to pick up anytime soon, with the European Central Bank last week cutting its forecast its growth for 2025 at 1.1%. Meanwhile, the president of the ECB, Christine Lagarde, said that the risks to growth "remain tilted to the downside".
This comes as GDP is expected to expand by 0.8% in the euro area this year, which is an improvement from 2023's annual growth rate of 0.4%, but a far cry from 2022's 3.4%. By comparison, US officials expect growth of 2.7% this year. Eurozone inflation is also in focus after briefly dipping below the ECB's autumn target of 1.8%, but rising again above the 2% target in November. As investors and economists try to decipher what's next for the region, here are the top five things they're looking at as they weigh Europe's prospects for 2025.
1. Monetary policy
Policymakers at the European Central Bank announced their fourth and final rate cut for the year last Thursday. Markets are pricing in another 25-point cut when the ECB's Governing Council makes its first policy decision in 2025, according to overnight index exchange data. For Kallum Pickering, chief economist at investment bank Peel Hunt, this is not going far enough. "The economic logic argues for 50 basis point moves, [but] I don't think they're going to go for 50 basis points," he said.
"I find the tone of the ECB very dovish," Pickering added, explaining that Europe's economic issues had shifted from supply shocks to demand problems, making it doubtful that inflation would still be "sticky" after six months old. Index swap data suggests that, like Pickering, most traders expect the ECB's base rate currently at 3% to be cut to 2% by mid-2025, with some predicting further cuts in the second half of the year.
In a note to clients in late November, analysts at Bank of America declared 2025 "the year the [ECB's] policy rate goes below 2%. "A rate [deposit target] of 1% is easily conceivable,” they added them.
2. Crisis of faith
A wary consumer is among the many headwinds facing Europe this year. In a flash estimate for November, the European Commission found that consumer confidence fell by 1.2 percentage points year-on-year in the euro area. Meanwhile, the European Commission's economic sentiment indicator, a confidence score drawn from surveys of businesses and consumers, while steady, has remained below its long-term average throughout the year and is currently slightly below where it ended 2023.
However, Sylvain Broyer, EMEA chief economist at S&P Global Ratings, said that monetary policy changes in Europe could help boost lagged confidence levels. "We think the ECB is in a position to accelerate rate cuts, which could help [growth] because confidence is still low despite the continued economic recovery," said Broyer, who is a member of the shadow council. of ECB economists last week.
"Fiscal policy has been restrictive over the last couple of years, if you add restrictive monetary policy, both legs of the policy mix in Europe have been restrictive if we change it a little bit for 2025 that could ultimately help."
3. Peripheral performance
Chris Watling, CEO and chief market strategist at Longview Economics, highlighted a divergence among European economies, with a handful of European countries set to see their economic fortunes turn. "On a two to three year view, Europe is going to have some good times," Watling said earlier this month. "I think Southern Europe is really exciting, it's the return of the PIIGS."
The acronym PIIGS refers to Portugal, Italy, Ireland, Greece and Spain, each of which has historically been considered vulnerable to economic instability and crises. The European Commission expects the country's GDP to grow by 3% this year and 2.3% in 2025, while the OECD expects Spain to see the third-strongest growth of all OECD countries this year. Meanwhile, Greek economic growth is expected to reach 2.1% in 2024 and 2.3% in 2025.
However, Watling's optimism for these countries comes despite a warning that Europe's financial markets could "struggle" in the first six months of 2025. "The best thing about having a crack in the markets in the first half is that it encourages central banks around the world to cut rates more and gives us that re-acceleration of the global economy at the end of next year in 2026," he said.
4. Fees
Although some good news may be on the horizon for Europe, a second Trump presidency and the tariffs that may come with it have the potential to create new obstacles. President-elect Donald Trump's threats to impose tariffs of 10% to 20% on all US imports have sparked uncertainty across European firms and led to questions about how the region might respond.
In its European Road Ahead report, Citi said a 10% tariff could cut EU GDP by 0.3% by 2026, "while a new US-China trade war could double the damage in countries exposed as Germany". "We think similar retaliation is unlikely, which would make this a deflationary blow, but global fragmentation will hurt trade-dependent Europe in the long run," the analysts added.
Janet Mui, head of market analysis at wealth manager RBC Brewin Dolphin, said the tariffs are likely to be used as a negotiating tool by the next US administration. "The tariff is certainly a key threat. But it's probably a reasonable assumption that Trump doesn't follow through on his threats," she added.
5. Political instability
Europe is also facing political uncertainty within its own borders, with two of the region's largest economies, France and Germany, in the throes of political turmoil. Former French Prime Minister Michel Barnier was ousted and replaced earlier this month, while German Chancellor Olaf Scholz lost a vote of confidence on Monday, paving the way for elections early next year. "Think of [Europe] as a souffle, and the growing part of the souffle was always France and Germany, and that has really collapsed into stagnation and paralysis," David Roche, a strategist at Quantum Strategy, said earlier this month. "Core Europe [looks] very bad economically and politically, and I think the markets will eventually reflect that."
Maximilian Uleer, head of European equity and cross-asset strategy at Deutsche Bank, said political uncertainty in Germany could actually spur a turnaround in the country's faltering economy, however. "Germany is known for its political stability, there have only been two instances of coalition disintegration in recent history," he said in a Dec. 16 note to clients. "Both times, Germany faced a recession, introduced reforms and emerged stronger... Don't underestimate Germany's capacity to change."
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