2025 Outlook: Europe’s economies brace for more political upheaval

Summary

In this episode of Strategic Alternatives, RBC experts Peter Schaffrick and Kahal Kennedy discuss Europe's economic outlook for 2025. They explore key macroeconomic forces such as inflation, growth, and the impact of low productivity. The conversation touches on the effects of political and policy shifts, geopolitical volatility, and fiscal dynamics across the EU, UK, and US. Despite challenges, the experts remain cautiously optimistic, highlighting opportunities in fixed income and credit markets, while also addressing concerns over tariffs and the broader economic environment. The discussion offers valuable insights for investors navigating these complex dynamics.

Takeaways

• 😀 Europe’s economic growth in 2025 is expected to be positive but weak, with growth projections around 1-1.5%, indicating a slow recovery with significant headwinds.
• 😀 Despite interest rate hikes in 2022 and 2023, the labor market has remained firm, and this resilience has contributed to better-than-expected growth.
• 😀 Inflation has decreased, which has allowed central banks like the ECB and the Bank of England to start cutting interest rates, supporting the economy going forward.
• 😀 While inflation is lower, domestically generated inflation, particularly in services, remains sticky, making it difficult for central banks to ease aggressively.
• 😀 Low productivity growth in Europe post-pandemic is a critical challenge for both growth and inflation control, further complicating central bank policies.
• 😀 The ECB and Bank of England are unlikely to cut rates significantly in 2025 due to persistent inflationary pressures, with rates likely staying within neutral territory.
• 😀 The Bank of England’s recent budget and fiscal policy changes suggest a more gradual and cautious approach to monetary easing, with a potential 100 basis points reduction in 2025.
• 😀 In Germany, political changes after elections are expected to lead to more fiscal loosening, which could help stimulate the economy and ease some of the financial constraints.
• 😀 Tariffs are a significant concern, as they may negatively impact Europe's trade-dependent economies, though they could also create inflationary pressures in the short term, particularly if the U.S. introduces tariffs on China.
• 😀 Despite various challenges, there is optimism for M&A activity and corporate credit in 2025, with high yields in corporate debt providing potential opportunities for investors.

Q & A

What is the general economic outlook for Europe in 2025, according to Peter Schaffrick?

Peter Schaffrick expects modest growth in Europe in 2025, with a GDP growth forecast around 1 to 1.5%. Despite challenges, including weak consumption, he does not foresee a major recession, largely due to the firm labor market and easing inflationary pressures.

Why has consumption in Europe remained weak despite improvements in real wage growth?

While real wage growth has increased disposable income, consumption has remained weak because savings rates have risen, with consumers choosing to save rather than spend. This indicates cautious consumer behavior in the face of economic uncertainty.

How are the European Central Bank (ECB) and Bank of England's approaches to interest rates evolving for 2025?

Both central banks are in a cutting cycle due to falling inflation. The ECB is expected to act more quickly, with rate cuts expected to reach a neutral level of around 2.25%, while the Bank of England is likely to adopt a more cautious approach with gradual cuts through 2025.

What impact is low productivity growth having on Europe's economy?

Weak or negative productivity growth in Europe post-pandemic is a significant challenge. It limits trend growth and reduces the potential for rising living standards, making it harder for central banks to manage inflation while stimulating economic activity.

How could fiscal policy in Germany change after the upcoming elections?

Post-election, Germany is expected to adopt a more supportive fiscal stance. This includes increased government spending and a likely relaxation of the 'debt brake' rules, allowing for greater fiscal stimulus to support the economy.

How might tariffs affect the European economy and inflation?

Tariffs, particularly those imposed by the US, are seen as potentially negative for Europe due to trade restrictions. However, they may also have a disinflationary effect if cheaper Chinese products flow into Europe. The overall impact on inflation is uncertain and could vary depending on the specific tariff scenario.

What are the main economic headwinds facing Europe in 2025?

The main headwinds include weak consumption, low productivity growth, geopolitical uncertainty, trade disruptions (especially with the US and China), and high budget deficits in some European countries, which could place pressure on the economy and markets.

What role will fiscal policy play in supporting the European economy in 2025?

Fiscal policy, particularly in Germany, is expected to provide more support in 2025. This could include fiscal loosening and potential changes to budgetary rules. However, the effectiveness of fiscal stimulus will depend on how governments balance spending with debt sustainability concerns.

What does the outlook for fixed income investments look like in 2025?

The outlook for fixed income is cautious, with short-duration assets being recommended due to the challenges of low productivity growth and high fiscal deficits. Long-duration assets may face additional pressure from debt sustainability concerns and widening fiscal policies.

What are the key opportunities for investors in 2025 despite the challenging economic backdrop?

Opportunities for investors include corporate credit, where yields remain high, and M&A activity, which is expected to be strong. While markets face economic challenges, these areas are seen as offering potential returns amidst a generally cautious outlook.