European economy faces danger of continued decline, economists say

The past year has been a tumultuous year for the euro zone, with its largest economies, Germany and France, seeing political and economic turmoil that means neither has a budget set for 2025.

Economists say the trajectory of both countries is worrying and warn that lack of growth, fiscal imbalances and political intransigence could lead to decline and a loss of prestige for Europe as a whole.

“The current situation is different from the previous (sovereign debt) crisis to the extent that Europe’s most acute problems are no longer concentrated in smaller economies like Greece. Instead, it is Europe’s two largest economies that are struggling,” Neil Shearing, the group’s chief economist. at Capital Economics said in an analysis in December.

“Europe faces continued decline without fundamental reform at its core,” Shearing said, noting that if this is not carried out, “it is difficult to escape the conclusion that Europe’s future is one of very low growth, continued concerns about fiscal sustainability and a waning sense of position in a world increasingly characterized by superpower rivalry between the United States and China.”

As things stand, neither France nor Germany have a 2025 budget amid political infighting that They finally overthrew their governments.

New elections will be held in Germany in February. and analysts are betting on new parliamentary elections in France next summer. The countries are now operating on interim budgets, after extending their tax and spending provisions from 2024 to this year, and it is unclear when any of them will agree on a 2025 budget.

France and Germany face different economic challenges, reflecting both the dangers of overspending and underspending.

France had a budget deficit estimated at 6.1% and debt estimated at 112% in 2024, according to the IMF. Prime Minister Francois Bayrou’s new government is expected to struggle to get warring MPs from all sides to approve a 2025 budget. like his predecessor Michel Barnier.

Meanwhile, Germany faces a snap federal election in February after Chancellor Olaf Scholz’s governing coalition collapsed in the fall. due to divisions over economic and budget policies. Germany’s problem is underspending and underinvestment that have led to declining economic growth.

“By contrast, Germany’s problem is overly tight fiscal policy,” said Capital Economics’ Shearing.

“Its so-called ‘debt brake’ significantly reduces the scope for deficit spending even though the German public debt burden is low. With a stagnant economy, Germany would benefit from more flexible fiscal policy, and since this it would almost certainly absorb imports from other countries. “This would help support growth (and therefore fiscal consolidation) in France and Italy,” he noted.

The European Central Bank has sought to boost economic activity in the euro zone Cutting interest rates, implementing a 25 basis point reduction in December. (its fourth cut this year) to bring its key rate to 3%. The central bank said it expected the euro zone economy to post growth of 0.7% in 2024 and 1.1% in 2025. Inflation in the bloc was estimated at 2.4% in 2024 and 2 .1% this year.

Risks to economic growth “remain tilted to the downside,” ECB President Christine Lagarde said at a press conference in December, warning of the potential for “further frictions in global trade” and that “lower confidence could prevent consumption and investment from recovering so quickly. as expected.”

Some analysts, such as Kallum Pickering, chief economist at Peel Hunt, told CNBC that the ECB should be bolder and seek further rate cuts in 2025.

Others say rate cuts can’t help fix structural problems, such as low productivity growthand headwinds, such as the potential tariffs on European imports destined for the US., which will probably be presented by the president-elect of the United States, Donald Trump.

“Our base case is that Europe will face a fairly difficult year in 2025,” Jari Stehn, chief European economist at Goldman Sachs, told CNBC, with the investment bank forecasting 0.8% growth for the euro zone in 2025. , compared to 2.5% for the eurozone. United States, during the same period.

“There are a lot of problems… high energy prices, the slowdown in China, political uncertainty, trade tensions are all negative things,” he told CNBC’s “Squawk Box Europe.” However, investors were still looking for potential bright spots in the region.

“People are wondering if in Germany, when there are new elections, we could get more fiscal support; maybe we think there will be some, but we think ultimately it will be limited,” Stehn said.

“People are also wondering if the European consumer could finally surprise on the upside, the savings rate is high, there is actually quite a bit of money (that could be spent), but again we think there will be some support, but it is unlikely that it will “It will be a great positive surprise.”

Stehn noted that lower interest rates “will go some way to helping consumers save and increase spending, and that’s one of the reasons we really think Europe will grow next year, despite these challenges.”

“But at the same time, I think we also have to be realistic about a lot of the headwinds that we’ve talked about (like) energy prices, China, structural issues. Cutting rates won’t solve all of those things.” . ” said.

“Ultimately, it will be a challenging environment.”