Eurozone: a mild recovery?

Key points

• Eurozone growth should recover mildly in 2025, while inflation should trend lower.
• Importantly, divergences are emerging, with countries in the ‘south’ outperforming those in the ‘north’. 
• And risks abound, in particular on the geopolitical front.
• This uninspiring macroeconomic outlook requires investors to be selective in the region.

Eurozone economic growth is going through a soft patch. Gross domestic product (GDP) is expected to increase by just  0.8% in real terms (that is, after adjusting for inflation) during 2024. However, this subdued performance hides much divergence between countries in the bloc.

In the ‘south’, Spain stands out, with growth on par with a racy US economy. Meanwhile, core areas, namely Germany and France, have seen a more muted performance, with the former contracting for the second consecutive year, held back by a languishing manufacturing sector. China’s economic struggles are partly to blame, but so too is the political uncertainty that followed the inconclusive French election.

Importantly, though, the eurozone’s inflation dynamics have been heading in the right direction, down. This allowed the European Central Bank (ECB) to be among the first of the main central banks to start cutting interest rates in 2024. With wage pressures abating, this trend should continue in 2025, with the deposit facility rate likely to be in the vicinity of 2% before the end of that year, closing in on the terminal rate, which we estimate to be just below that figure.

Some green shoots

At face value, with inflation seemingly under control, this puts the eurozone in a potentially very strong position heading into 2025. In fact, we’ve seen supportive data, in regards to monetary development, for September, confirming an upturn in household credit creation with an uptick in credit flows to non-financial corporates. 

This combination of low inflation, lower rates and a low base, could drive a significant improvement in GDP growth – albeit absolute expansion is likely to remain subdued – of around 0.7% in 2025, in our base-case scenario (see table).

Labour market dynamics, as captured by our Macroeconomic Momentum Indicators, have picked up of late, substantiating the economic recovery. Despite large German auto manufacturers looking to cut jobs, even the traditionally more sensitive measures, such as under-employment, eased in 2024.

While labour-market momentum supports consumption, many key economies are not as reliant on consumer spending for growth as, for example, the US economy is: German and French household expenditure only accounted for 51% and 54% of GDP in 2023, respectively, while it was 68% for the US.

The economy’s openness works as both a strength and a weakness. In 2024, it was a weakness. But, in 2025 the European ‘renaissance’ could be further strengthened by the bloc’s outsized exposure to China. That is if that country’s stimulus plans bear fruit and reignite its economy, of course.

Politics to spoil the party?

The real risk for the eurozone is a political one. Whether it is domestic politics frustrating the recovery, or geopolitics putting pressure on an economy that remains very open to the world, the region’s economic fate is heavily influenced by policymakers. The immediate risk here is driven by the election of Donald Trump in the US. Furthermore, the conflicts in Ukraine and the Middle East remain pressing issues that could disrupt the outlook for the bloc.

Domestically, France’s outlook is clouded by an inconclusive snap election, called by President Macron in June. Meanwhile, in Germany the coalition government refuses to remove the country’s fiscal brake, and this is unlikely to change until the federal election in 2025.

Fiscal strains

As a result, France and Germany may not be able, or willing, to support eurozone growth as much as they would like, or need to. On that note, a key factor to watch in 2025 will be the outcome of the German election.

Similarly, the Italian government is still trying to take the country out of the European Union’s (EU) Excessive Deficit Procedure (EDP), a fate that could be achieved in 2026, at the earliest. Finally, and although its fiscal situation improved in 2024, Spain’s debt-to-GDP ratio remains above 100%, giving the country limited room for manoeuvre.

Therefore, any real fiscal support probably lies in the hands of the EU. There are still very significant Recovery Fund (NGEU) disbursements expected over the next couple of years, and, as highlighted in September by the former ECB President  Mario Draghi’s report on the bloc’s competitiveness¹, additional investments are required. Unfortunately, this may not be enough to overturn the contractionary stance of European fiscal policy in 2025.

Weak growth, but still investment appeal

In this context, and as an investor, it’s difficult to get overexcited about the eurozone’s prospects. Yet, everything has a price. Furthermore, below the surface, the bloc remains an attractive hunting ground for active managers. As such, our focus is on select idiosyncratic opportunities, both in public and private markets, in 2025.