Our economic outlook for the euro area
February 21, 2025
Our outlook for year-end 2025
0.5%
Economic growth,
year over year
We continue to forecast below-trend growth around 0.5% in 2025. The prospect of additional tariffs and related uncertainty would likely weigh on consumer and business sentiment, and continued malaise in the manufacturing sector is likely to weigh on final demand. GDP increased by 0.1% on a seasonally adjusted basis in the fourth quarter and by 0.7% for all of 2024.
1.9%
Core inflation, year over year
Stubborn services inflation caused the pace of headline inflation to increase for a fourth consecutive month in January. Headline inflation rose to 2.5% year over year, up from 2.4% in December. The pace of services inflation remained stubborn at 3.9% year over year. However, without the contributions of the insurance, transport, and tourism sectors, services inflation would be closer to 2%. We have high conviction that these drivers will fade in the coming quarters. Amid weak growth, we expect both headline and core inflation to end 2025 below 2%.
1.75%
Monetary policy rate
The European Central Bank (ECB) cut its deposit facility rate by 25 basis points to 2.75% on January 30, the fourth consecutive quarter-point cut and fifth overall in a rate-cutting cycle that began in June 2024. The monetary policy statement struck a dovish tone, as did ECB President Christine Lagarde in her press conference, where she said the economic outlook was “set to remain weak in the near term” and that risks to both growth and inflation tilt toward the downside. We continue to expect the ECB to cut the policy rate by 25 basis points at each meeting until the July meeting, and then hold it at 1.75%, just below our estimate of the neutral rate.
6.9%
Unemployment rate
Measures of wage growth are cooling materially, and unemployment rates are starting to rise. Real-time wage surveys in both the public and private sectors and compensation agreements in Germany suggest that wage growth will fall to close to 3% year over year from above 5% in 2024. Forward-looking surveys point to labor market weakness amid below-trend growth. The unemployment rate rose to 6.3% in December, up from a revised record low of 6.2% in November. In Italy, the unemployment rate rose from 5.9% to 6.2% as the number of unemployed people jumped by 87,000. With economic contraction in Germany and broader growth pressures, we foresee the euro area unemployment rate rising toward 7% by the end of 2025.
What I’m watching
Weakness in the industrial heart of Europe
The euro area’s biggest economy contracted in 2023 and is likely to do so again in 2024, weighed down by weakness in manufacturing. Germany’s industrial sector has suffered from both higher energy prices, triggered by the war in Ukraine, and a slowdown in external demand, particularly from China. A reversal of those headwinds may be the surest route to the stabilization—and eventually the recovery—of German manufacturing, which will be an important ingredient in a wider euro area recovery.
Shaan Raithatha, CFA
Vanguard Senior Economist
German industrial production
Notes: The chart shows the German Industrial Production Index alongside sub-indexes for energy-intensive and China-exposed production sectors from January 2021 through July 2024. All indexes are adjusted to have a starting value of 100 at the beginning of 2021. Energy-intensive sectors include chemicals, base metals, paper products, and refined petroleum. China-exposed sectors include manufacturing, electrical, and motor vehicles. The weights represent the share of revenue generated by the sectors in relation to the total revenue generated by German industrial production.
Sources: Vanguard calculations, based on German Federal Statistical Office data from Bloomberg.
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