Summary
- The Eurozone economy is entering 2025 on an unsteady and uncertain footing. While household fundamentals are still favorable overall, they may become less supportive as 2025 progresses, suggesting the pace of consumer spending could slow. The outlook for the corporate sector remains challenging, and a further decline in investment spending cannot be ruled out.
- In addition to mixed fundamentals, sentiment has slipped through the latter part of 2024. Political uncertainties in France and Germany, and concerns surrounding the threat of U.S. tariffs on imports from Europe, are factors that have weighed on sentiment. Given the mixed fundamental backdrop and softening sentiment, our Eurozone GDP outlook for 2025 is for growth of just 0.9%. However, considering the prevailing uncertainties, we view the risks to even this modest outlook as to the downside.
- Considering the underwhelming Eurozone economic outlook, and even with some lingering inflation pressures, we expect the European Central Bank (ECB) to continue steadily along its monetary easing path through much of 2025. We maintain our outlook for 25 bps ECB rate cuts at the January, March, April and June meetings, with a final 25 bps rate cut in September, for a terminal ECB policy rate of 1.75%. The growing wedge between European Central Bank and Federal Reserve policy interest rates is likely, in our view, to keep the euro on the defensive versus the greenback over the medium term.
Eurozone Outlook Remains Uncertain And Unsteady
The Eurozone economy stagnated in 2023, in response to a spike in energy prices and inflation, and as European Central Bank monetary policy moved into restrictive territory. The region’s economy has since experienced a recovery starting from early 2024, although that rebound has been uneven—a trend we think is likely to continue in 2025 given distinctly mixed fundamentals and as sentiment surveys remain downbeat.
Among the brighter pieces of recent economic news, Eurozone Q3 GDP grew 0.4% quarter-over-quarter, lead by a 0.7% gain in consumer spending. There are also indications that consumer activity may have continued expanding during the fourth quarter, with real retail sales for the October-November period up 0.4% compared to their third quarter average. However, while consumer fundamentals remain favorable overall (and certainly more so than for the corporate sector), there are signs they may become less supportive as 2025 progresses.
For the latest available figures (Q3-2024), growth in real employee compensation (3.1% year-over-year) and household disposable income (2.3%) outpaced growth in consumer spending (1.0%). While those favorable income trends would usually be considered supportive for the consumer outlook, the European Central Bank argued in a recent Economic Bulletin article that household savings could remain high, as households aim to rebuild their “real” net wealth that has been eroded by inflation in recent years. That is consistent with the Q3 household saving rate, which fell slightly to 15.3% of disposable income, but remains noticeably above the average of 13% in the year prior to the pandemic. Finally, while employment growth has held up to date, survey data suggest a slowdown in job gains may be ahead. The European Commission’s Employment Expectations Indicator fell to 97.3 in December, a level that is historically consistent with job growth well below its current pace of 1.0% year-over-year in Q3-2024. Thus, while household fundamentals are favorable overall, they may become less supportive as 2025 progresses. Overall, we expect consumer spending will continue to advance this year. However, the combination of the potential for slower employment (and thus income) growth and continued consumer caution suggests gains in consumer expenditures may struggle to match the pace seen during the second half of 2024.
In contrast to the household sector, the outlook for the corporate sector remains more challenging. In Q3-2024, fixed investment spending rose 2.0% quarter-over-quarter, however much of that rise reflected a jump in the volatile intellectual property products component. We estimate that our measure of core ex-housing investment (which excludes both residential investment and intellectual property products) fell 1.6% quarter-over-quarter and 2.4% year-over-year. Moreover, we see reasons for investment spending to remain restrained in the quarters ahead. Net entrepreneurial income, a proxy for corporate profits, fell 4.6% year-over-year in Q3, a lack of profitability that may crimp investment spending. With manufacturing capacity utilization also at its lowest level since the pandemic, a further decline in investment spending cannot be ruled out.
Sentiment Slips Amid Rising Risks
In addition to these mixed fundamental factors, sentiment has slipped through the latter part of 2024, suggesting some downside risk to business investment in particular, and consumer spending to a lesser extent. Eurozone sentiment was at its most upbeat earlier in 2024, with the services PMI peaking at 53.3 in April and the manufacturing PMI peaking at 47.3 in May. Since then, however, Eurozone sentiment has followed a softening overall trend. By December the manufacturing PMI fell further into contraction territory at 45.1, while the services PMI was consistent with only modestly positive expansion at 51.6. As result, the composite (or economy-wide) PMI printed at 49.6, a level historically consistent with a stagnating economy.
Political uncertainty has weighed on sentiment to some extent, with French President Macron’s centrist ruling coalition losing legislative elections in July, and the new French Prime Minister (and government) subsequently losing a vote of no-confidence in December. German Chancellor Scholz also lost a confidence vote late last year, with an election now scheduled for 23 February. Another factor likely weighing on sentiment is the threat of U.S. tariffs on imports from Europe. While the economic impact may be moderate—with Eurozone merchandise exports to the United States accounting for a little more than 3% of the region’s GDP—the uncertainty surrounding tariffs could certainly weigh on investment spending and employment decisions.
Given the mixed fundamental backdrop and softening sentiment, our Eurozone GDP outlook for 2025 is for growth of just 0.9%. However, considering the prevailing uncertainties, we view the risks to even this modest outlook as to the downside.
European Central Bank Easing to Continue At a Steady Pace
Considering the underwhelming Eurozone economic outlook, and even with some lingering inflation pressures, we expect the European Central Bank (ECB) to continue steadily along its monetary easing path through much of 2025. Eurozone headline and core inflation are running moderately above the central bank’s 2% inflation target, with January readings of 2.4% year-over-year and 2.7% year-over-year respectively. Services inflation is proving somewhat more stubborn at 4.0%. Still, with ECB policymakers expecting wage growth to slow and services inflation to ease, overall inflation is expected to converge more sustainably toward the 2% target by later in 2025. Moreover, we expect the European Central Bank to lower its policy interest rate largely independent of how fast, or how far, the Federal Reserve eases monetary policy. ECB policymakers have said as much in recent days. Governing Council member Olli Rehn said against “the backdrop of disinflation being on track and the growth outlook having weakened it makes sense to continue rate cuts” adding the ECB “is not the 13th federal district of the Federal Reserve System, we take decisions on the basis of our mandate, which is price stability in the euro area.” Croatia’s Boris Vujcic said “we are not dependent on the Fed or any other central bank,” while Chief Economist Philip Lane said the ECB is likely to reduce rates further in order to ensure price stability and growth. Considering the economic environment and central bank signals, we maintain our outlook for 25 bps ECB rate cuts at the January, March, April and June meetings, with a final 25 bps rate cut in September, for a terminal ECB policy rate of 1.75%. Moreover, given a growing wedge between European Central Bank and Federal Reserve policy interest rates, we expect the euro to remain on the defensive versus the greenback over the medium term. As of now, we target a long-term EUR/USD exchange rate of $0.9700.
