As Europe moves into 2025, the region faces a mixed economic landscape, with modest recovery projected but significant risks ahead.
The latest EY ‘European Economic Outlook’, a quarterly publication issued by the EY’s EMEIA Economic Analysis Team, provides a comprehensive analysis of Europe’s economic performance in the second half of 2024, an outlook for 2025-2026, and the risks and opportunities that could shape the region’s future.
Economic performance in 2024
The second half of 2024 saw slow economic growth across Europe. Consumption showed a slight uptick as real incomes rose, but exports struggled due to weak industrial output.
Meanwhile, investment remained subdued, hindered by tight monetary policies, low external demand and pessimism in the business sector. Government spending helped mitigate some of these challenges, but overall fiscal policies weighed on growth.
Among Europe’s economies, Malta stood out as a strong performer, reporting a 5.4% year-on-year real GDP growth in 2024 Q3. Malta also stands out as one of the fastest-growing economies since 2019. Overall, the euro area’s economy stands 4.6% above its pre-pandemic level, with notable variations among member states.
Employment conditions stabilised in the euro area, though there were disparities between countries. Wage growth remains elevated and is not yet aligned with the ECB’s inflation target.
Economic outlook for 2025-2026
Looking ahead, the euro area is expected to see a modest economic recovery in 2025, with growth forecasted to rise from 0.7% in 2024 to 1.3% in 2025 and 1.8% in 2026, before slowing to 1.4% in 2027. Malta’s GDP growth in 2025 is expected at 4%, the highest among European countries.
Employment growth is anticipated to slow across the euro area due to weaker labour demand and demographic pressures, while unemployment is expected to stabilise at 2024 levels. Nominal wage growth is projected to decline in 2025, though it will remain above pre-pandemic levels due to ongoing labour market tightness.
Inflation trends and price pressures
Inflation remains a concern, especially in services prices. While overall inflation in the euro area is expected to remain slightly above 2% in 2025, certain areas, including Central and Eastern European countries, will likely face higher inflation, driven by factors such as wage pressures.
Central Bank policies and rate cuts
The European Central Bank (ECB) has already started to ease monetary policy and further rate cuts are anticipated in 2025. EY’s analysis suggests that the ECB’s current monetary policy is too restrictive, given that the neutral interest rate in the euro area is notably low. EY estimated nominal natural interest rates for the euro area and the US.
Several risks threaten economic outlook
The findings indicate that in the euro area, the natural interest rate remains below 1% and suggest the ECB’s deposit rate should be under 2%. In contrast, the US natural rate is much higher, close to 3%.
Following the US elections, bond yields have risen, with the increase being more pronounced in the US and UK than in continental Europe, leading to a stronger USD against the EUR.
Key risks and opportunities
Several key risks threaten Europe’s economic outlook, with the outcome of the US elections further skewing the balance of risks for GDP growth to the downside and slightly heightening inflation risks. Some key risk factors include:
◾ Potential higher tariffs which could hurt European exports, particularly in manufacturing-heavy economies. EY has undertaken a separate analysis of these tariffs and their potential impact.
◾ Ongoing tensions in Ukraine and the Middle East could lead to commodity price spikes and supply chain disruptions.
◾ Higher energy costs and competition from China could worsen the industrial downturn in Europe.
◾ Uncertainty might make businesses and consumers cautious, delaying recovery.
◾ Weather events and political unrest could disrupt energy and food supplies, raising inflation and slowing growth.
◾ High-debt countries in Southern Europe and emerging markets remain vulnerable to bond market pressures, especially as inflation no longer reduces debt burdens.
Despite these risks, there are opportunities for stronger growth in Europe. These include:
◾ A faster decline in services inflation and stable core goods prices could boost household spending and allow central banks to cut rates, stimulating growth.
◾ Households could spend excess savings from the pandemic, boosting economic activity.
◾ Tight labour markets could drive investments in automation, AI and robotics, increasing productivity and growth.
◾ Higher immigration could ease labour shortages and support long-term growth.
Despite headwinds from inflation, geopolitical risks and global economic uncertainties, Europe will likely experience a modest acceleration in growth in 2025. The key to a stronger recovery will be navigating these risks while capitalising on opportunities.
Glenn Fenech is an economist within the valuations, modelling and economics service line at EY Malta, and Maciej Stefański is a senior economist at EY EMEIA Economic Analysis Team. For a comprehensive analysis, you can access the full January 2025 EY European Economic Outlook publication at EY European Economic Outlook – January 2025 | EY – Global.