Moderate recovery vs mounting risks: what to expect from Europe's economy in 2025

After five consecutive quarters of stagnation, the euro area economy saw modest growth in 2024, marked by slow but steady progress, reported Xinhua. Yet, much like the fleeting brilliance of New Year's Eve fireworks, uncertainty lingers over 2025.

Germans welcomed 2025 with renewed hope despite economic challenges, as the country looks toward recovery in the months ahead. The festive spirit over the past week marked a shift in mood, reflecting aspirations for brighter prospects for Europe's largest economy.

After five consecutive quarters of stagnation, the euro area economy saw modest growth in 2024, marked by slow but steady progress. Yet, much like the fleeting brilliance of New Year's Eve fireworks, uncertainty lingers over 2025. Geopolitical tensions, rising protectionism, and mounting pressure from U.S. policies present significant risks, threatening to disrupt Europe's fragile recovery.

WEAKER-THAN-EXPECTED GROWTH FORECAST

The eurozone's GDP is projected to grow by 0.8 percent in 2024, driven by easing inflation and a recovery in consumption and investment, according to the lastest forecast by the Organisation for Economic Co-operation and Development (OECD). Growth is expected to accelerate to 1.3 percent in 2025 and 1.5 percent in 2026, while the European Central Bank (ECB) remains more cautious, predicting growth at 1.1 percent and 1.4 percent respectively.

Inflation continued to ease throughout the past year, largely due to the sharp drop in energy prices. After falling to 1.7 percent in September, inflation rebounded to above 2 percent since October. Annual inflation is forecast at 2.4 percent for 2024 -- more than halving from the previous year -- before gradually slowing to 2.1 percent in 2025. Core inflation, which excludes food and energy, is expected to approach the ECB's 2-percent target by late 2025 as wage growth moderates and services inflation softens.

While lower inflation and stronger labor markets have boosted disposable incomes, the ECB has warned that weak consumer confidence and economic uncertainty may lead to higher household savings, potentially damping short term growth.

Thiess Petersen, senior advisor at the Bertelsmann Stiftung, said "2025 would be another year of considerable economic risks for Europe," noting that sluggish growth in Germany continues to weigh down the broader bloc.

Structural challenges, particularly underinvestment, remain a key obstacle for Germany. In December, major think tanks lowered their forecasts, with the ifo Institute projecting a 0.1-percent contraction for 2024. This could mark Germany's first consecutive annual recessions in over two decades.

Germany's debt brake, or Schuldenbremse, which caps annual deficits at 0.35 percent of GDP, is facing growing scrutiny. ING Research estimates that the country needs additional public investment equivalent to 1.5 percent of GDP annually over the next decade to offset years of underfunding. Without such measures, stagnation could persist through 2025, further straining Europe's economic recovery.

DOWNWARD RISKS SHADOWING OUTLOOK

Despite modest growth in 2024, Europe's economic outlook remains fraught with risks, ranging from geopolitical tensions and persistent energy vulnerabilities to escalating trade disputes and political unrest.

A December report from the German Economic Institute revealed that 31 out of 49 business associations reported deteriorating conditions over the past year, with high energy costs cited as a primary concern.

The expiration of the EU's gas transit deal with Russian via Ukraine on Jan. 1 has further heightened uncertainly. Brussels-based think-tank Bruegel estimates the bloc now faces an annual shortfall of 140 terawatt hours. While liquefied natural gas imports may help bridge the gap, the costlier and less reliable alternative risks placing additional strain on consumers and industries across the EU.

Adding to the challenges, Europe's export-driven economy faces potential disruptions from the United States, where President-elect Donald Trump has pledged to impose tariffs on all imports. A Financial Times survey of 72 economists identified global trade tensions and regional political paralysis as the biggest threats to the eurozone in 2025.

"A looming trade war with tariffs of 10 percent to 20 percent on European goods could push the eurozone economy from sluggish growth into recession," warned Carsten Brzeski, global head of macro at ING Research.

Political instability in France and Germany, the EU's two economic engines, deepens the uncertainty. France's fragile government under President Emmanuel Macron faces mounting debt and opposition from the far-right, while early elections in Germany destabilize the political landscape, hampering efforts to revive the eurozone economy.

Such political upheaval in Europe's powerhouses is a clear threat to eurozone growth, Brzeski noted in a separate report.

MONETARY STIMULUS CONSTRAINED

On the first trading day of 2025, the euro continued its decline, falling below 1.03 against the U.S. dollar -- its lowest level in more than two years. The currency has depreciated by 8 percent since last September, deepening concerns over the worsening economic outlook for the eurozone.

Markets are increasingly factoring in the widening gap between U.S. Federal Reserve and ECB monetary policies. Analysts at Dutch commercial bank ABN Amro predict that "this will push the euro to parity with the dollar over the course of 2025."

A growing concern is the ECB's ability to stimulate economic momentum for the bloc in 2025. The central bank has already cut key interest rates four times over the past year, responding to easing inflation and sluggish growth. In a recent speech, ECB President Christine Lagarde emphasized that maintaining "sufficiently restrictive" rates is no longer necessary, citing slowing growth and moderating price pressures.

Calls are mounting for a more accommodative monetary stance, with suggestions that the ECB could lower rates by an additional 100 basis points in 2025 to support a potential recovery. Lagarde, however, has hinted at a "neutral rate" in the coming year -- a level that neither restricts nor stimulates the economy.

"Our decision reflects the conviction that a gradual, data-dependent approach remains the most appropriate strategy," said Isabel Schnabel, a member of ECB's executive board. Her remarks signal the bank's cautious approach as it navigates toward a neutral rate, while ensuring inflation stabilizes around the 2-percent target.