Our economic outlook for the euro area
March 12, 2025
Our outlook for year-end 2025
1.0%
Economic growth,
year over year
The likelihood of a significant increase in government spending as part of Germany’s announced infrastructure and defense program, a broader increase in defense spending across Europe, and the prospect of a ceasefire in Ukraine lead us to upgrade our forecast for 2025 euro area GDP growth from 0.5% to 1%. We have additionally increased our 2026 euro area GDP growth forecast, from 0.8% to 1.6%. We can’t discount the prospect of even greater growth. However, significantly higher tariffs remain a key risk. Our calculations suggest that significant tariffs on U.S. imports of European Union goods for an extended period would largely offset the gains from expansionary fiscal policy in both 2025 and 2026.
1.9%
Core inflation, year over year
Recent stickiness in services inflation is largely attributable to insurance, tourism, and transport—and we anticipate price normalization in all three industries in the coming months. Inflation eased in February. Headline inflation registered 2.3% year over year, down from 2.5% in January, while core inflation (which excludes volatile food, energy, alcohol, and tobacco prices) was 2.6% year over year, down from 2.7% in January. Services inflation, which has remained sticky, eased to 3.7% year over year from 3.9% in January. We continue to expect headline and core inflation to end 2025 below 2%. However, given the prospect of above-trend growth, we’ve raised our 2026 core inflation forecast by 20 basis points to 2.1%.
2.25%
Monetary policy rate
An environment more conducive to growth, driven by higher structural deficits amid anticipated increases in region-wide defense spending and Germany’s planned 10-year, €500 billion infrastructure fund, leads us to forecast a slower European Central Bank (ECB) easing cycle and a higher terminal rate than we previously envisioned. We now expect the ECB to end its cutting cycle with the deposit facility rate at 2.25%, higher than our previous forecast of 1.75%, suggesting just a single 25-basis-point cut remains in the cycle. The ECB cut its deposit facility rate by 25 basis points to 2.5% on March 6, the fifth consecutive quarter-point cut and sixth overall in a rate-cutting cycle that began in June 2024.
6.4%
Unemployment rate
Increased defense spending across Europe and Germany’s announced infrastructure program are likely to forestall what we had expected to be a deterioration in the euro area labor market. Where we had foreseen a gradual rise to near 7% in the unemployment rate over 2025 from a current record low of 6.2%, we now expect only a modest rise in the unemployment rate given the new fiscal impulse.
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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