Key Takeaways
- We forecast that economic growth in the eurozone will strengthen, reaching the potential in 2025. Inflation will moderate, reaching 2.0% in the second half of 2025.
- Against this backdrop, the European Central Bank (ECB) is likely to keep cutting rates once per quarter until the deposit rate reaches 2.5% in the third quarter of next year.
- Consumers should become more cognizant of disinflation, and lower interest rates should make saving less appealing. Consumer spending should therefore pick up and align more closely with purchasing power, driving GDP growth.
- Private-sector loan demand is showing signs of life about six months earlier than previous interest rate cycles would have suggested. That said, the credit impulse--the change in new credit as a percentage of GDP--is likely to remain modest as long as monetary policy remains restrictive, which should be the case until late 2025.
- Visibility on the economic outlook is relatively poor, with a downturn in the labor market, more restrictive fiscal policy, and less supportive foreign trade all still possible.
S&P Global Ratings expects eurozone GDP growth of 0.8% this year and 1.3% next year, largely in line with our previous forecasts of 0.7% and 1.4%, respectively. However, we now expect stronger growth for Spain and France this year, and weaker growth for Germany. Consumer spending, and from next year, investment, should become the main drivers of GDP growth as real income growth accelerates, consumer perceptions of disinflation improve, and interest rates fall.
Inflation, at 2.2% in August, could edge up again toward the end of the year. It is not likely to recede to 2.0% before the second half of 2025 as unit labor costs continue to rise quickly. We estimate inflation at 2.5% this year and 2.1% next year, almost unchanged from our previous forecasts of 2.4% and 2.2%, respectively.
In terms of monetary policy, we continue to see the ECB cutting rates by 25 basis points (bps) per quarter until the deposit rate reaches 2.5% in the third quarter of 2025, compared with 3.5% currently. We understand that 2.5% is the upper limit of consensus estimates of the neutral rate. The neutral rate is the interest rate at which the central bank doesn't exert any pressure on demand, either restrictive or stimulative. This means that monetary policy is gradually becoming less restrictive but will not be neutral before late 2025.
Yet several factors cloud our visibility on the economic outlook. Labor costs are still rising quickly, especially in industry, making a more pronounced downturn in the labor market possible. Fiscal policy could be more restrictive next year, while foreign trade could be less supportive of growth. Geopolitical factors could erode confidence and disrupt supply chains. Falling confidence indicators, often at odds with hard data, add informational noise.
Spain And France Contribute Most To Eurozone Growth
Eurozone GDP was up 0.2% in the second quarter of 2024. This was the second consecutive quarter of expansion after more than a year of stagnation due to the energy price shock. However, not all member states are contributing evenly to the recovery. Spain and France in particular have been among the main engines of the eurozone's economic growth over the past four quarters, while Germany continues to hold it back (see chart 1).
Chart 1
The short-term outlook for France and Spain looks good. The Olympics could add as much as one-quarter of a point to France's GDP in the third quarter of 2024, while there are several factors driving Spain's broad-based growth (see "Economic Outlook Eurozone Q3 2024: Growth Returns, Rates Fall," published June 24, 2024, on RatingsDirect). We expect the German economy to gradually catch up with its peers from the second half of 2024, as the inflation differential shrinks.
Disinflation Has Yet To Register With Consumers
Inflation moderated to 2.2% in August 2024 from 2.5% in June 2024, when we prepared our previous forecasts. As before, energy remains the main driver of disinflation. Food inflation edged down to 2.3%, while services inflation remained at 4.1% on strong demand and high wage growth.
On the bright side, growth in goods prices excluding energy has almost come to a halt, standing at 0.4% year on year compared to more than 5.0% a year ago. Inflation expectations have also improved. Both the ECB Survey of Professional Forecasters and the options markets foresee inflation in one, two, and five years' time aligning with the central bank target for the first time since the 2022 energy-price shock.
However, perceptions of inflation differ. According to the European Commission's consumer survey, households are feeling the effects of disinflation to a much lesser extent than the official price measure (see chart 2). This gap between perceived and measured inflation could explain some of European consumers' spending restraint at the start of the year. However, this bodes well for spending in the coming quarters, as the fall in inflation should start to register in consumers' minds.
Chart 2
A better perception of disinflation is not the only reason why we expect household consumption to strengthen over the rest of the year. The labor market remains robust, with the unemployment rate reaching a new all-time low of 6.4% in July 2024. Year-on-year employment growth of 1.0%, year-on-year wage per capita growth of 4.3%, and a slowdown in the consumption deflator to 2.7% imply real income growth of almost 3.0%. At the same time, year-on-year consumer spending has only increased by 0.1% since the start of the year and is still at the same level as before the pandemic.
Only the consumption of services and durable goods has improved. Consumption of nondurable and semi-durable goods is still down so far in 2024 (see chart 3). This is a sign that the cost-of-living crisis has hit low-income households much harder than others. We believe that the consumption of nondurable and semi-durable goods could catch up gradually as real income rises and perceptions of disinflation improve. Overall, we expect consumption to contribute to GDP growth in the second half of 2024 and even more so in 2025.
Chart 3
Falling Interest Rates Will Encourage Consumers To Spend More Amid Full Employment
Lower interest rates are another reason why we believe that consumers will support GDP growth later this year and next. Since the ECB began raising rates in mid-2022, European households have been saving more money than usual, mostly to benefit from a higher return on their savings. The personal savings rate rose from 12.8% of gross disposable income (GDI) to 15.4% between mid-2022 and early 2024, the period when the ECB was raising interest rates.
Flow-of-funds statistics show that European households spent up to 3.5 percentage points of their GDI investing in debt securities over that period (see chart 4). Today, interest rates have started to fall, and we expect them to continue to do so. This should lift consumer spending.
Chart 4
Recent monetary developments support this view, suggesting that monetary policy has started to drag less on demand. Banknotes and currency in circulation, the most liquid monetary aggregate, M1, has stopped falling for the first time in a year. Growth in short-term deposits other than overnight deposits (M2 excluding M1) is slowing. This indicates that Europeans are not shifting cash to less liquid bank accounts as readily as before.
As the counterparts of monetary aggregates, outstanding loans to the private sector (adjusted for sales and securitization) have returned to moderate expansion of 1.3% year on year after stagnating last year. According to the ECB's euro area bank lending survey, eurozone banks expect the demand for loans to gather pace in the third quarter of 2024, and for housing loans even more than other private-sector loans (see chart 5). This nascent recovery in housing loans has started about six months earlier than in previous interest rate cycles, mainly thanks to a strong labor market (see "European Housing Markets: Better Days Ahead," published July 17, 2024).
Chart 5
The Credit Impulse Should Remain Modest, As Monetary Policy Will Not Be Neutral Before Late 2025
Monetary policy is likely to remain in restrictive territory until the third quarter of 2025. At this stage, we see no reason for the ECB to speed up the easing cycle. We don't think the ECB will accelerate its rate cuts just because of the Federal Reserve as it still has the problem of sticky domestic inflation. Markets may push the ECB to do more at some point, but as long as the eurozone economy is gently stabilizing, we're not there yet. Wage growth, even though it is decelerating, remains far higher than productivity growth, adding to the pressure on core inflation. By historical standards, the eurozone is at full employment, and GDP growth is likely to reach the potential by next year. In this context, we expect the ECB to keep cutting rates gradually, by 25 bps each quarter, with the rate-cutting cycle over by September 2025, when the deposit rate reaches 2.5%.
The policy rate will therefore remain above the neutral rate until late 2025. The neutral rate is an unobserved variable that is hard to estimate, and so it cannot be a precise compass for monetary policy. That said, it is not totally useless, and several metrics place it within a range of -50 to +50 bps in real terms. This is why we envisage the end point of this ECB rate-cutting cycle to be around 2.5% in nominal terms, at the upper end of consensus estimates of the neutral rate.
As far as quantitative tightening is concerned, we believe that the ECB's new operational framework of demand-driven liquidity injections for banks will not accelerate the current reduction in the Eurosystem's balance sheet. Under this new framework, the ECB plans to continue to use long-term credit operations and to introduce a structural bond portfolio--probably from 2026--to distribute liquidity to banks. This month, the ECB also lowered the spread between the main refinancing operations and the deposit facility rate to 15 bps from 50 bps. This is unlikely to encourage eurozone banks to turn away from the central bank and toward the money markets in their search for liquidity (see "European Banks: Preparedness is Key to Unlocking Central Bank Funding," published Sept. 17, 2024).
The ECB's balance sheet will therefore continue to shrink, mainly through the repayment of the existing longer-term refinancing operations, which still stand at €85 billion, and the non-reinvestment of maturing bonds in its pandemic emergency purchase program and asset purchase program portfolios. These portfolios total €4,400 billion and have been diminishing at an average pace of €30 billion a month since the beginning of the year (see chart 6).
Chart 6
Visibility On The Economic Outlook Remains Low
An exceptionally high number of factors could derail our baseline scenario and weigh on economic growth. First, many leading indicators stopped improving over the summer, with some even pointing south, such as the Purchasing Managers' Index (PMI). That said, there is a disconnect between soft data like the PMI and hard GDP data that makes the interpretation of the soft data less straightforward than usual. Composite PMI has already undergone several mini cycles over the past two-and-a-half years, all led by the services sector, without affecting GDP growth much (see chart 7).
Chart 7
A more pronounced deterioration in the labor market than we expect is also possible, since the increase in unit labor costs remains strong by historical standards, at 5.2% for the total economy and 6.5% for industry (see chart 8).
Wage demands remain high and are even in two-digit territory in some countries and sectors. The surge in inflation in 2022 has undermined European companies' price-setting power significantly, and unit profits have absorbed a significant part of the increase in unit labor costs over the past four quarters (see chart 9).
As a result, employers may be tempted to reduce employment levels to stabilize their profit margins. The European Commission's business survey shows that employment expectations have weakened in services and construction and are negative in industry (see chart 10).
Chart 8
Chart 9
Chart 10
Fiscal policy could become more restrictive than we expect next year after the European Commission proposed excessive deficit procedures against five eurozone countries, including France and Italy. In its spring forecasts, the European Commission expected fiscal consolidation in the cyclically adjusted primary balance next year of just 0.1% of potential GDP on average at the eurozone level, following consolidation of 1% this year (see chart 11).
Chart 11
In its latest fiscal monitor, the IMF expects budgetary consolidation of 0.3% of potential GDP next year. We'll have to wait for the discussion of national budgets in the autumn to find out more. The European Commission must submit its proposed excessive deficit procedures to a vote by the European Council before it can apply them.
What's more, net external trade, the main driver of the eurozone's economic recovery over the past two quarters, could weaken due, possibly, to:
- A harder landing of the U.S. economy;
- Continued weakness in Chinese domestic demand, and/or China's retaliation for the tariffs that the European Commission has proposed on the import of electric vehicles if they are maintained; and
- A deterioration in Europe's trade competitiveness (for more on Europe's trade competitiveness, see "Europe Must Avoid The Middle Technology Trap To Continue Reaping Free Trade Rewards," published Sept. 5, 2024).
These are not the only risks weighing on our macroeconomic outlook. Geopolitical and domestic political factors could still undermine confidence and disrupt supply chains. While sales-price expectations are tame, freight costs are rising again due to strong demand for transport and blockages on the Red Sea route. The nascent recovery in European industry at the start of the year came to a halt in the spring, with structural adjustments in the car sector at play, and manufacturing output continues to fluctuate from month to month.
Table 1
| S&P Global Ratings' European economic forecasts (September 2024) | |||||||||
|---|---|---|---|---|---|---|---|---|---|
| Eurozone | Germany | France | Italy | Spain | Netherlands | Belgium | Switzerland | U.K. | |
| GDP | |||||||||
| 2022 | 3.4 | 1.4 | 2.6 | 4.1 | 5.8 | 5.0 | 3.0 | 3.1 | 4.3 |
| 2023 | 0.5 | -0.1 | 1.1 | 1.0 | 2.5 | 0.1 | 1.4 | 0.7 | 0.1 |
| 2024 | 0.8 | 0.2 | 1.1 | 0.9 | 2.7 | 0.6 | 1.2 | 1.3 | 1.0 |
| 2025 | 1.3 | 1.1 | 1.2 | 1.1 | 2.1 | 1.5 | 1.3 | 1.5 | 1.3 |
| 2026 | 1.4 | 1.3 | 1.4 | 1.1 | 2.0 | 1.4 | 1.4 | 1.4 | 1.6 |
| 2027 | 1.3 | 1.1 | 1.3 | 1.0 | 2.0 | 1.5 | 1.3 | 1.5 | 1.7 |
| CPI inflation | |||||||||
| 2022 | 8.4 | 8.7 | 5.9 | 8.7 | 8.3 | 11.6 | 10.3 | 2.8 | 9.1 |
| 2023 | 5.4 | 6.0 | 5.7 | 5.9 | 3.4 | 4.1 | 2.3 | 2.1 | 7.3 |
| 2024 | 2.5 | 2.7 | 2.5 | 1.4 | 3.0 | 3.0 | 4.0 | 1.3 | 2.6 |
| 2025 | 2.1 | 2.2 | 1.9 | 1.9 | 2.1 | 2.6 | 2.2 | 1.1 | 2.3 |
| 2026 | 1.9 | 1.9 | 1.8 | 1.7 | 2.0 | 2.0 | 2.0 | 1.1 | 2.0 |
| 2027 | 1.8 | 1.9 | 1.7 | 1.7 | 1.8 | 2.0 | 1.9 | 1.0 | 2.0 |
| Unemployment rate | |||||||||
| 2022 | 6.7 | 3.1 | 7.3 | 8.1 | 13.0 | 3.5 | 5.6 | 4.4 | 3.9 |
| 2023 | 6.5 | 3.0 | 7.4 | 7.7 | 12.2 | 3.6 | 5.5 | 4.1 | 4.0 |
| 2024 | 6.5 | 3.4 | 7.5 | 7.0 | 11.6 | 3.7 | 5.6 | 4.2 | 4.3 |
| 2025 | 6.5 | 3.3 | 7.6 | 7.4 | 11.4 | 3.9 | 5.5 | 4.3 | 4.4 |
| 2026 | 6.3 | 3.1 | 7.5 | 7.3 | 11.3 | 3.9 | 5.5 | 4.1 | 4.4 |
| 2027 | 6.2 | 3.1 | 7.4 | 7.3 | 11.2 | 3.8 | 5.4 | 4.0 | 4.4 |
| 10-year government bond (yearly average) | |||||||||
| 2022 | 2.0 | 1.2 | 1.5 | 3.2 | 2.2 | 1.4 | 1.7 | 0.8 | 2.3 |
| 2023 | 3.3 | 2.5 | 2.9 | 4.3 | 3.5 | 2.8 | 3.1 | 1.1 | 3.9 |
| 2024 | 3.0 | 2.4 | 2.9 | 3.8 | 3.1 | 2.7 | 2.9 | 0.6 | 3.9 |
| 2025 | 2.9 | 2.2 | 2.8 | 3.8 | 3.0 | 2.5 | 2.7 | 0.8 | 3.6 |
| 2026 | 2.9 | 2.3 | 2.8 | 3.9 | 3.0 | 2.6 | 2.8 | 1.0 | 3.5 |
| 2027 | 3.0 | 2.3 | 2.8 | 3.9 | 3.1 | 2.6 | 2.9 | 1.0 | 3.5 |
| Eurozone | U.K. | Switzerland | |||||||
| Exchange rates | USD per euro | USD per GBP | Euro per GBP | CHF per USD | CHF per euro | ||||
| 2022 | 1.05 | 1.23 | 1.17 | 0.95 | 1.00 | ||||
| 2023 | 1.08 | 1.24 | 1.15 | 0.90 | 0.97 | ||||
| 2024 | 1.10 | 1.29 | 1.18 | 0.89 | 0.98 | ||||
| 2025 | 1.15 | 1.33 | 1.16 | 0.91 | 1.05 | ||||
| 2026 | 1.17 | 1.29 | 1.10 | 0.91 | 1.06 | ||||
| 2027 | 1.17 | 1.28 | 1.09 | 0.91 | 1.06 | ||||
| Eurozone (ECB) | U.K. | Switzerland (SNB) | |||||||
| Policy rates (end of year) | Deposit rate | Refi rate | Bank rate | ||||||
| 2022 | 2.00 | 2.50 | 3.25 | 1.00 | |||||
| 2023 | 4.00 | 4.50 | 5.25 | 1.75 | |||||
| 2024 | 3.25 | 3.40 | 4.71 | 0.75 | |||||
| 2025 | 2.50 | 2.65 | 3.33 | 0.75 | |||||
| 2026 | 2.50 | 2.65 | 3.00 | 0.75 | |||||
| 2027 | 2.50 | 2.65 | 3.00 | 0.75 | |||||
Related Research
- European Banks: Preparedness is Key to Unlocking Central Bank Funding, Sept. 17, 2024
- Europe Must Avoid The Middle Technology Trap To Continue Reaping Free Trade Rewards, Sept. 5, 2024
- European Housing Markets: Better Days Ahead, July 17, 2024
- Economic Outlook Eurozone Q3 2024: Growth Returns, Rates Fall, June 24, 2024
External Research
- "R(ising) star?," speech by ECB board member Isabel Schnabel, March 2024
- "The natural rate of interest: estimates, drivers, and challenges to monetary policy," by Adrian Penalver et al., ECB Working paper 217, December 2018
This report does not constitute a rating action.
| EMEA Chief Economist: | Sylvain Broyer, Frankfurt + 49 693 399 9156; sylvain.broyer@spglobal.com |
| Economists: | Aude Guez, Frankfurt 6933999163; aude.guez@spglobal.com |
| Sarah Limbach, Paris + 33 14 420 6708; Sarah.Limbach@spglobal.com |
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