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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is a financial journalist and writes the Wealth of Nations newsletter
As 2024 draws to an end, it is hard to be optimistic about Europe. Its politics become ever more fragmented and polarised. Germany may be without a stable government until at least after elections in late February, France may have to wait until 2027 when President Emmanuel Macron’s term ends.
Growth has stalled, unemployment is expected to rise. The economy has been held back by burdensome regulation, high energy prices, weak demographics, growing competition in manufacturing sectors and a failure to keep pace with Chinese and American technological advances. Much of the continent is grappling with excessive debt even as governments are under pressure to deliver big increases in defence spending.
The consensus forecast is for growth of just 1.1 per cent next year. Some are even gloomier: Bank of America expects growth of just 0.9 per cent in 2025. Even this assumes that Donald Trump imposes only modest tariffs on Europe on his return to the White House. Risks to growth are overwhelmingly to the downside, according to the latest European Central Bank survey of independent economists.
This pessimism is reflected in markets. European stocks may be trading at close to record highs but they have sharply underperformed US equities. The Euro Stoxx 600 index now trades at a record 40 per cent discount to the S&P 500 index based on next year’s forecast earnings. While US households have never been more optimistic about stocks and US fund managers have never held less cash, global fund managers are underweight European equities and no one expects them to outperform other markets in 2025, according to the latest Bank of America survey of investors.
Yet so much pessimism also sets a very low bar for upside surprises. What could go right in Europe in 2025 that could lift the mood? Several things spring to mind.
The most immediate is that the ECB stops worrying about inflation and moves decisively to support growth. Cutting its benchmark interest rate to 1.5 per cent or below from the current 3.0 per cent could help revive confidence in sectors that have been struggling, including real estate and construction, reckons Gilles Moëc, group chief economist at Axa. It would also support decarbonisation projects that run on long time horizons and ease some of the fiscal pressure on governments.
Second, an early end to the war in Ukraine on terms that Kyiv could accept would remove one of the darkest clouds that have hung over the continental economy over the past two and a half years, particularly if it led to lower energy prices. The rebuilding of Ukraine and its integration into the EU single market would stimulate economic activity. That would be a gradual process but the boost to confidence would be immediate. Such a deal may seem unlikely now, but recent events in Syria are a reminder at how quickly the wheel of geopolitical fortune can turn.
Another boost could come via relaxation of Germany’s debt brake. Friedrich Merz, the frontrunner to be the country’s next chancellor, may currently be ruling this out, at least until the election. But it is hard to square his Christian Democratic Union party’s commitment to increase defence spending and cut taxes without more borrowing. With everyone from Angela Merkel to the current president of the Bundesbank now throwing their weight behind reform of the debt brake, looser fiscal policy seems likely. Meanwhile, a determined programme of supply-side reforms could lift German growth by up to 0.5 percentage points next year, reckons Holger Schmieding, chief economist of Berenberg Bank.
A further upside surprise could be progress in implementing Mario Draghi’s recent recommendations on how to boost the EU’s competitiveness. Expectations are currently low, not least because of opposition to any fresh issuance of common debt. Yet much of the former Italian prime minister’s deregulatory agenda does not require extra funding or even legislation. Besides, there are signs that resistance to new debt issuance to fund defence spending may be weakening as Europe scrambles to provide for its own security and forestall Trump’s tariff threats.
Some argue that progress on reform is unlikely because Europe lacks strong leadership, particularly in France and Germany. Yet others are filling the void. Ursula von der Leyen’s decision to fly to Brazil in the first week of her new mandate to sign the EU-Mercosur trade agreement, for example, showed that the European Commission president is unafraid to take political risks in pursuit of a deal that is patently in the bloc’s economic and geopolitical interest. She at least seems to recognise the gravity of the moment — and is prepared to rise to it. Perhaps 2025 will be the year when Europe positively surprises us.
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