Expert insight
The end of stagnation for Europe and the U.K.
June 25, 2024
After months of stagnation, the euro area and the U.K. have finally started to grow again. The European Central Bank (ECB) has already started easing its monetary policy, and the Bank of England (BOE) may not be far behind. But future cuts will depend on continued progress in the fight against inflation.
The euro area economy expanded by 0.3% and the U.K. economy grew by 0.6% in the first quarter compared with the fourth quarter of 2023, breaking the recent trend of very slow or negative growth. This uptick was driven by recovering real household incomes and an improved outlook for the global economy, which helped boost exports and reignite business confidence. We expect growth to continue for the rest of the year, driven by further gains in real incomes and easing financial conditions, though we expect activity to be restricted by still-weak manufacturing.
The euro area and the U.K. have recovered but are likely to remain below pre-COVID trend
Notes: The solid lines show real GDP for the euro area and the U.K. indexed to 100 as of the fourth quarter of 2019. The dotted line shows the pre-COVID trend for both economies. The two dots are Vanguard forecasts for the end of 2024.
Sources: Vanguard calculations using data as of June 10, 2024, from Eurostat and the Office for National Statistics. Vanguard forecasts thereafter.
The last mile of the fight against inflation is proving challenging. Inflation in the energy, food, and core goods components is now closer to the long-term trend, but prices for services—the stickier portion of the consumption basket—have yet to normalize. The firmer outlook for growth has contributed to a reacceleration in service prices over the last three months, as inflation momentum has broadened across countries and sectors, posing a significant upside risk to the inflation outlook.
Although wage growth remains elevated, we expect pay growth will moderate given forward-looking indicators of wage setting and a softening of the labor market. We expect headline inflation to return to target by year-end in the euro area and in the first quarter of 2025 in the U.K. Core inflation likely won’t return to target in each region until the first quarter and second quarter of 2025, respectively.
On the policy front, the ECB has moved first in commencing the easing cycle, with a cut of 25 basis points (0.25 percentage points) this month. We expect a quarterly cadence of such rate cuts, with two more coming this year and four next year, which would leave the policy rate at 2.25% at the end of 2025.
The BOE is in a similar situation, with its first cut likely to come in August. Thereafter, we expect the bank rate to be cut by an additional 25 basis points before the end of this year, then further cuts next year totaling a percentage point, bringing the rate to 3.75% by the end of 2025. However, risks skew toward less easing for both central banks, as pressures from services prices may push policymakers to take a more cautious approach.
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