What outlook for the Eurozone economy in 2025?

Little seems to be going right for the euro zone. The recovery in growth seems to be flagging, incumbent governments are losing their majority, and external threats are rising with respect to both Trump and Russia. At least, inflation is low, and the ECB is cutting rates. Indeed, it may have to cut more than most expect given these headwinds. Eurozone’s economic growth in 2025 is expected to be barely better than the 0.8% outturn the Standard Bank anticipates for 2024.

This bank currently pitches Eurozone’s 2025 growth at 1.0%, which is short of the 1.3% the ECB anticipates and the 1.2% that forms the median projection of analysts contributing to the Bloomberg survey. The broad assumption is that the consumer sector will improve on the basis of rising real wwages and lower housing costs as ECB rates fall. This latter influence can be expected to lift other interest-sensitive sectors of the economy, such as investment.

While these seem reasonable assumptions, we must take account of the headwinds to stronger growth. These include domestic political turmoil in several countries, not least France and Germany where incumbent governments have lost their majority. On top of this, there are numerous external headwinds, including increased strains between the West and Russia over arming Ukraine, and potential new tariffs from US president-in-waiting Donald Trump.

Steve Barrow, Head of Standard Bank G10 Strategy, thinks that these factors are likely to keep the business and consumer mood somewhat cautious and so frustrate hopes for a strong rebound in economic growth. The recent slump in the composite PMI survey seems likely to mean a downturn in economic growth in the near term. The corollary of this economic vulnerability is likely to be inflation that not only meets the ECB’s 2% target but falls too far. The ECB puts CPI inflation at 2.2% next year and 1.9% in 2026.

“We feel that these estimates are too high and, if so, it should create room for the Bank to be more aggressive with its rate cuts than generally assumed. Right now, the market is priced for the ECB to take the deposit rate down from its current 3.25% rate to the 1.75%-2.0% range over the coming year. We believe that rates can fall to 1.5% and we would not rule out the possibility of still lower rates, such as the paucity of future growth and future inflation”, said Steve Barrow.

Such an outlook for policy easing would seem to give rise to expectations for sharp falls in bond yields. However, just as budget concerns seem to have led to higher treasury yields in the US, despite Fed easing, so too have some eurozone countries been blighted in the same manner, such as France given its political impasse. So, while we do think that euro zone bond markets will broadly outperform treasuries and 10-year yields will come down to around 1.5% in core markets, such as Germany, this will occur in the context of significant steepening in yield curves. The euro is proving a casualty of the relative weakness in the euro zone economy, the prospect of deeper rate cuts than the Fed, and the potentially adverse impact of rising geopolitical concerns around Russia. As a large open economy, the euro zone is also under particular threat from new tariffs levied by the incoming Trump administration in the US.

In short, all roads seem to lead to a lower euro across the board, not just against the US dollar. A test of parity against the US dollar appears likely but it may be weakness against other currencies like the yen and the pound that prove more durable over the long haul. One reason for this is that economic underperformance has been very common in the euro zone relative to the US, and yet the euro has not fallen significantly.

“If we look at 2023 and 2024, for instance, the euro has mostly been inside a 1.05-1.10 range, up until very recently, and yet US growth was 2.5% points above that of the euro zone in 2023, and it is likely to be 2% points above in 2024. How can the euro have performed so ‘well’ given this enormous economic deficit? The answer might lie in the fact that US outperformance is partly driven by large capital inflows, the counterpart of which are large current account deficits. The euro zone, in contrast, has a robust trade position and, in the end, this may just mean that any push to, or through parity, for euro/dollar proves temporary rather than long-lasting”, said Steve Barrow.