We expect eurozone GDP growth will reach 0.8% in 2024 and 1.2% in 2025. Our base-case scenario has changed little--and mainly due to revisions to past GDP data--since our previous publication as there are only a few indicators to draw on. We expect Germany's GDP growth will fall short of eurozone peers' next year, while Spain will continue to outperform (see chart 1). Inflation will be slightly lower in 2024 than we had expected (2.4% versus 2.5% previously) because of a more pronounced decline in energy prices. Yet the underlying price trend remains intact, with prices potentially stabilizing over the near term.

Chart 1

Macroeconomic Forecasts Could Become More Volatile

The changes to our previous GDP forecasts largely reflect revisions to official GDP data for 2023 and second-quarter 2024.  These revisions have lowered the growth carry-over for 2024 and 2025, especially for Italy and Germany. We now expect higher short-term volatility in foreign trade and a weaker euro exchange rate following the outcome of the U.S. election. Since several reasons for continuing a restrictive monetary policy have dissipated, we now anticipate that the ECB will increase the pace--but not the extent--of rate cuts due to persistently weak confidence and better visibility on the disinflation trajectory. ECB rates could turn neutral, with the deposit facility rate potentially reaching 2.5% before the summer of 2025, rather than September 2025 as we had anticipated previously.

Market expectations regarding the development of the U.S. economic policy imply a slight steepening of the euro yield curve.  Since a stronger dollar and higher U.S. yields would possibly attract more capital from Europe, we revised upward our working assumptions on German bond yields by 20 basis points to an average of 2.4% in 2025. The increase in government bond yields is reflected across the eurozone.

Recent developments have confirmed several of our previous forecasts.  The strong and ongoing disinflation to 2% in third-quarter 2024, from a peak of 10% in fourth-quarter 2022, has not resulted in job losses. Total employment increased by 0.2% in third-quarter 2024, for the 14th consecutive quarter, while the unemployment rate in the eurozone has reached a new multi-decade low of 6.3% in September this year. Eurozone GDP has increased by 0.4% in third-quarter 2024, largely spurred by household spending.

Households are starting to feel the increase in purchasing power.  Additionally, lower interest rates mean they have less incentives to save money. As a result, spending on non-durables--mostly nonfood and internet sales--is gradually recovering (see chart 2). Eurozone GDP growth remains modest but has accelerated to 0.9% year over year, the fastest increase in 18 months. Barring a new shock, lower interest rates and another increase in households' purchasing power should result in the continuous strengthening of the eurozone economy over the coming quarters. That said, our base-case scenario could change significantly over the next few quarters, with macro forecasts becoming more unstable than they have been in years.

Chart 2

Three Policy Pivots Could Reshape Our Base Case

1 - New U.S. leadership

President-elect Donald Trump proposed to tighten immigration controls, extend the 2017 Tax Cuts and Jobs Act, cut corporate taxes, and raise tariffs on imports from China and other countries by 60% and 10%, respectively. Although it is too early to assess the extent and the sequence in which the campaign program will be implemented, all these measures have the potential to alter the economic outlook for the eurozone.

The U.S. is the main destination for European exports.  In 2023, it accounted for 17% of total exports, 2.6% of the EU's GDP, and 3.6% of German GDP. The pharmaceutical, chemical, and automotive sectors are most exposed to U.S. demand. That said, all European sectors export to the U.S. European exports to the U.S. exceed those to China, with the exception of computers, electronics, and electrical equipment (see chart 3). We previously estimated that a universal 10% increase in U.S. tariffs would reduce real GDP by about 0.2% in the eurozone and 0.3% in Germany, which would be more affected than Spain, Italy, and France. Considering these elasticities, a potential tariff shock seems to be manageable for the eurozone economy, especially if it is offset by a persistent appreciation of the U.S. dollar against the euro. The bilateral exchange rate has weakened by 3% since the U.S. election.

Chart 3

A lower tariff surcharge on European exports, compared with Chinese exports, does not necessarily disadvantage Europe.  China and Europe are major exporters of machinery equipment, chemicals, and optical and medical equipment to the U.S. market. This could change if the new U.S. administration adopted a differentiated approach to tariffs and applied a country- or sector-specific--rather than a universal--surtax that would be based on the size of the U.S. trade deficit (see chart 4).

Chart 4

The timing of higher U.S. tariffs is important.  During the first Trump administration, it took 10 to 12 months from investigation to tariff implementation. We expect implementation will be quicker this time and assume Mr. Trump will announce tariff increases within the first 100 days in office, with another 60 days for businesses to adjust plans or file for exemptions. This means imposition could occur by the beginning of third-quarter 2025. In our global base case, we expect higher tariffs on China but no universal tariffs, at least at this stage. We might adapt our outlook once we have more clarity.

That said, it is not just the tariff-based trade elasticity that we will need to consider. We also take into account the new U.S. administration's bundle of measures and its effects on (i) the U.S., (ii) demand from the rest of the world--particularly from China--for products from Europe, and (iii) financial markets.

2 - New EU leadership

A new Council President (António Costa succeeding Charles Michel on Dec. 1, 2024), a new Commission, and a new rotating EU Presidency (Poland succeeding Hungary) will gradually take office over 2024-2025. Policy priorities have been set--among others by the Council's strategic agenda--and discussed extensively in 2024.

2025 will be a year of action.  Three high-profile reports by Christian Noyer, Enrico Letta, and Mario Draghi increased European policymakers' conviction to tackle Europe's loss of competitiveness against the U.S. and China, unify the region's capital markets to unlock the growth potential offered by European countries' abundant savings, streamline regulation, and rationalize and increase Europe's defense effort. European countries' ability to implement the reforms that are outlined in these three reports is uncertain. Bold actions, especially in terms of EU defense spending, could improve the economic outlook. Based on 2023 data from the Stockholm International Peace Research Institute, the additional budgetary effort required by EU countries that are also NATO members to meet NATO's military spending targets would amount to about 0.4% of European GDP annually, with Germany bearing the brunt (see chart 5).

Chart 5

EU leaders' reaction to potential U.S. tariffs is uncertain.  The EU adopted a new framework, the so-called Anti-Coercion Instrument (ACI), at the end of 2023. This framework foresees the use of tariffs as a countermeasure against any kind of trade restrictions affecting the EU, but only as a last resort. The EU remains committed to promoting free markets, with the ACI prioritizing negotiations over any other defense measures.

3 - Fiscal policy rules

In our previous macroeconomic outlook, we pointed out that the reinstatement of European budgetary rules required some countries, including France and Italy, to consolidate fiscal policy. Germany's decision to hold snap elections on Feb. 23, 2025, adds a new layer of uncertainty. The elections could result in the EU's largest member state increasing its fiscal space, although we remain skeptical that Germany will call into question the debt brake. The eurozone's monetary and fiscal policy have dampened domestic demand over the past two years (see chart 6). We expect monetary policy will turn neutral in 2025, while fiscal policy will remain restrictive.

Chart 6

Confidence Remains Weak, Labor Markets Appear More Fragile

Apart from having a direct effect on demand and financing conditions, the three policy pivots could affect confidence (see chart 7).  The dichotomy between soft (confidence) data and hard (demand) data persists. Confidence indicators in the eurozone are still weak. The upturn in spring 2024 has remained transitory (see chart 7), despite the significant decline in inflation, historically high employment rates, and the resumption of economic growth. Low confidence resulted from the successive shocks to the European economy since 2020--related to the COVID-19 pandemic, geopolitical tensions, and political factors--the restrictive policy mix over the past two years, and the ongoing debate about the loss of Europe's competitive edge in global markets, compared with the U.S. and China. Additionally, consumer prices have not declined yet, despite easing inflation. Energy and food prices even remain at historic highs, with low-income households most affected (see chart 8).

Chart 7

Chart 8

We believe the current slowdown in the labor market could accelerate in 2025.  The fact that the strong disinflation in the eurozone, which has been underway since fourth-quarter 2022, did not result in job losses is unusual. Normally, central banks know that a certain sacrifice must be made in terms of unemployment to get inflation back to the target. The absorption of rapidly rising labor costs by employers' profit margins could explain this paradox. We have said previously that this equilibrium is unstable and that the expected productivity rebound in 2025 might be insufficient to rebalance it. The Beveridge curve, which reflects the relationship between job vacancies and unemployment rates, confirms our assessment (see chart 9). Job vacancies declined to 2.7% in second-quarter 2024, which is close to the 2.4%-2.5% level that preempted a rise in unemployment rates in previous cycles.

Chart 9

Monetary Policy Could Become Less Restrictive Over The Short Term

We expect the ECB will increase the pace of rate cuts, but not the extent.  Persistently weak confidence could hamper the translation of lower policy rates into an increase in domestic demand, particularly for investments and major household purchases. Additionally, external headwinds could weaken the eurozone's recovery. That said, the ECB has stated that it is more confident about getting inflation back to the target level. We therefore believe that monetary policy could become neutral before the summer of 2025, rather than September 2025 as we had anticipated previously.

With medium-term inflation risks still high, we continue to expect the ECB will stop cutting interest rates when they reach the upper band of the neutral rate interval estimates.  This corresponds to a deposit facility rate of 2.5% in nominal terms. Yet uncertainties about the level of the terminal rate have increased. We think the ECB could cut rates further to 2% in 2025 if foreign and domestic factors were to jeopardize the ongoing recovery.

Chart 10

Related Research

• Germany Brief: Debt Brake Could Continue To Complicate Policymaking After Snap Elections, Nov. 12, 2024
• After Trump's Win, What's Next For The U.S. Economy?, Nov. 7, 2024
• Economic Outlook Eurozone Q4 2024: Consumer Spending To The Rescue, Sept. 24, 2024
• Europe Must Avoid The Middle Technology Trap To Continue Reaping Free Trade's Rewards, Sept. 5, 2024
• Credit FAQ: The Next European Commission's Policy Choices: A Credit Perspective, July 17, 2024

External Research

• "Anti-coercion instrument: the EU's new weapon to protect trade," European Parliament, published on Oct. 3, 2023
• "The 2018 US-China Trade Conflict After 40 Years Of Special Protection," Peterson Institute for International Economics, published on April 24, 2019