Economic growth in the Euro Area surprises to the upside in Q1. Output growth in the Euro Area (EA) outpaced expectations in Q1, growing by 0.4% quarter-on-quarter (q/q) according to Eurostat’s flash estimates,. It is Germany and Italy that surprised to the upside, expanding by 0.2% and 0.3%, respectively. Spain maintained its strong growth momentum (+0.6% q/q), and France grew by a less impressive 0.1%. Though details on expenditure remain scarce, investments and private consumption had both a positive impact on GDP growth in Germany and Spain. In France and Italy growth was mostly skewed towards positive changes in inventories. Finally, excluding volatile Irish data that usually skew the EA's GDP growth figures due to the strong presence of multinational corporations, EA growth in Q1 would have been a less buoyant 0.2%.
Looking forward, trade uncertainty clouds the outlook. We expect Q1’s better-than-expected growth to be short-lived as intensified trade tensions and uncertainty following April 2nd’s tariff shock put widespread pressure on sentiment. The European Commission’s consumer confidence indicator declined in April, from -14.5 to -16.7, reaching its lowest point since November 2023. Increased pessimism about the EA’s economic outlook over the next year was the key drag in overall confidence. From the business perspective, the composite Purchasing Managers’ Index also fell, though less steeply, from 50.9 a month ago to a smaller-than-feared and still positive 50.1. The small decline was likely due to the fact that the timing of the survey followed the 90-day tariff pause. Sectoral PMI figures revealed that the drop in business confidence stemmed not from a slowdown in manufacturing, but rather a drop in services sentiment. This reflects growing concerns that rising volatility could dampen further consumers’ spending. Simultaneously, fresh data from the ECB’s quarterly lending survey also point to lower investment and consumption expectations in Q2, with major banks now expecting demand for short-term loans and credit/house loans to decrease in the near-term. All things considered, we see economic activity in Q2 coming in weaker than in Q1 as substantial uncertainty around trade - on top of ongoing geopolitical tensions - cloud business decisions and discourage major purchases. However, upside risks cannot be ignored. Assuming tariff talks between the US and major trading partners take a more constructive turn, growth should start picking up from Q3 onwards and even accelerate in 2026, supported by increased defense spending. In conclusion, while we make no changes to our 2025 and 2026 projections, stronger Q1 numbers push our forecasts slightly higher than from a month ago, now estimating the Euro Area economy will grow by 1.0% in 2025 and 1.2% in 2026.
Inflation stabilizes at 2.2% in April as energy prices fall but services inflation spikes. Annual headline inflation in the EA remained unchanged at 2.2% in April. Though energy prices declined sharply year-on-year (-3.5%), they were offset by a spike in services inflation (+3.9% y/y) primarily due to one-off factors (seasonal effects) linked to the Easter holidays. Food prices also increased, from 2.9% to 3%, while annual goods inflation remained unchanged at 0.6%. Looking ahead, while inflation remains close to the ECB’s 2% target, the near-term outlook continues to be uncertain following April’s tariff shock. On one hand, escalating US-China trade tensions could prompt the latter to reroute some of its excess capacity toward Europe, exerting downward pressure on prices. Lower energy costs and softer demand expectations may also contribute to weaker inflation. On the other hand, failure to secure a trade agreement between Europe and the US - or the threat of retaliatory measures – could drive prices higher. We expect more clarity on how price pressures will unfold in the short term as the 90-day tariff pause nears its end. As a result, we leave our inflation forecasts unchanged from last month, still projecting overall inflation in the EA to average 2.1% in 2025 before easing to 1.9% in 2026, while core inflation is projected to average 2.3% and 1.9% in 2025 and 2026, respectively.
Weak growth prospects in Q2 and protracted uncertainty pave the way for a June cut. On April 17th, the European Central Bank (ECB) lowered its key rates by 25 basis points (bp), bringing its main policy rate (i.e., deposit) to 2.25%. In the press conference that followed, there was a shift in focus from inflation to concerns about the EA’s weak growth prospects. Given that latest data reinforce these fears, we now expect the ECB to ease further its deposit rate in June – almost certainly by another 25 bp. Beyond June, however, predicting the ECB’s next move is more complicated. On the one hand, disinflationary pressures are already mounting in the region, which would in principal prevent the ECB from easing further. But if growth prospects continue to deteriorate on the other, the bank will have to apply even more accommodative policies. We await more information to understand how the balance of arguments will play out and make no changes to our monetary policy forecasts. We still project one more cut in June and then a pause at 2% for the remainder of the year. However, incoming data over the second quarter will be critical on whether we lower further our rate expectations – and bring it closer to market expectations - especially if new figures point to a further weakening in the economy.
Despite signs of slowdown, the labor market remains robust. Latest labor market data continues to indicate a solid and resilient jobs environment in the Euro Area. Despite weaker economic activity, unemployment rate remained unchanged in March at the all-time low of 6.2% and timelier employment data even showed the region continued to add workers in the last quarter of 2024. More recently, signs of the labor market cooling have continued to build. Job vacancies are falling fast to their pre-pandemic levels and hiring intentions in key sectors like manufacturing and construction have become less favorable. Nevertheless, we still expect the EA labor market to retain its positive outlook in the near-term, also due to the limited impact the US tariffs are likely to have on unemployment within the forecast horizon.
Policy uncertainty continues to be exceptionally high while we are monitoring pockets of conflicts erupting globally. We identify three issues to watch next.
- Europe prepares a €100 billion retaliatory package against the US if trade talks fail. The European Union is working towards a set of countermeasures that could hit approximately 100 billion euros worth of US goods according to latest reports by Bloomberg. For now, details are scarce. The package is only designed to be used if trade talks fail and the US administration applies the 20% ‘reciprocal’ tariff on EU exports. In the meantime, and in an effort to ease trade tensions, the EU has offered to purchase more US goods (e.g., agricultural products or liquified natural gas), eliminate all tariffs on industrial goods (including cars) and even offered the possibility of increasing investments in the US. For the moment, tariffs in place include those on EU cars, steel and aluminum as well as a 10% blanket tariff on all EU-produced goods entering the US. Assuming trade talks fail, and EU’s countermeasures come into effect, a full-fledged trade war with the US would be inevitable, an outcome which would put even greater pressure on EA’s already fragile economy.
- Romania’s first round of elections point to a nationalist outcome. George Simion, a right-wing nationalist candidate, won comfortably the first round of presidential elections on May 4th against Bucharest’s liberal mayor Nicusor Dan. Simion secured around 41% of the vote, winning in 36 out of 41 cities in Romania and receiving overwhelming support from Romanians living abroad. A vocal Eurosceptic, an open supporter of Donald Trump and a keen opposer of any military aid to neighboring Ukraine, a potential Simion victory would have far-reaching implications for Romania’s future. At the EU-level, it adds another country to the list of those that obstruct EU decision making. As a small country, however, this is not expected to be a real obstacle.
- From Europe to the Middle East and South India, conflicts flare up. Prospects of an all-out war between Pakistan and India have increased more recently, following a week-long military exchange between the two countries. In the Middle East, a potential new Israeli offensive against the Palestinians threatens to throw the region into even deeper turmoil and humanitarian crisis. On top of that, fresh Israeli attacks on Houthi targets in Yemen have raised the risk of a broadened military conflict in the Arabian Peninsula. This already adds to a turbulent world economy that is unable to cooperate to guarantee peace.
Economic growth in the Euro Area surprises to the upside in Q1. Output growth in the Euro Area (EA) outpaced expectations in Q1, growing by 0.4% quarter-on-quarter (q/q) according to Eurostat’s flash estimates,. It is Germany and Italy that surprised to the upside, expanding by 0.2% and 0.3%, respectively. Spain maintained its strong growth momentum (+0.6% q/q), and France grew by a less impressive 0.1%. Though details on expenditure remain scarce, investments and private consumption had both a positive impact on GDP growth in Germany and Spain. In France and Italy growth was mostly skewed towards positive changes in inventories. Finally, excluding volatile Irish data that usually skew the EA's GDP growth figures due to the strong presence of multinational corporations, EA growth in Q1 would have been a less buoyant 0.2%.
Looking forward, trade uncertainty clouds the outlook. We expect Q1’s better-than-expected growth to be short-lived as intensified trade tensions and uncertainty following April 2nd’s tariff shock put widespread pressure on sentiment. The European Commission’s consumer confidence indicator declined in April, from -14.5 to -16.7, reaching its lowest point since November 2023. Increased pessimism about the EA’s economic outlook over the next year was the key drag in overall confidence. From the business perspective, the composite Purchasing Managers’ Index also fell, though less steeply, from 50.9 a month ago to a smaller-than-feared and still positive 50.1. The small decline was likely due to the fact that the timing of the survey followed the 90-day tariff pause. Sectoral PMI figures revealed that the drop in business confidence stemmed not from a slowdown in manufacturing, but rather a drop in services sentiment. This reflects growing concerns that rising volatility could dampen further consumers’ spending. Simultaneously, fresh data from the ECB’s quarterly lending survey also point to lower investment and consumption expectations in Q2, with major banks now expecting demand for short-term loans and credit/house loans to decrease in the near-term. All things considered, we see economic activity in Q2 coming in weaker than in Q1 as substantial uncertainty around trade - on top of ongoing geopolitical tensions - cloud business decisions and discourage major purchases. However, upside risks cannot be ignored. Assuming tariff talks between the US and major trading partners take a more constructive turn, growth should start picking up from Q3 onwards and even accelerate in 2026, supported by increased defense spending. In conclusion, while we make no changes to our 2025 and 2026 projections, stronger Q1 numbers push our forecasts slightly higher than from a month ago, now estimating the Euro Area economy will grow by 1.0% in 2025 and 1.2% in 2026.
Inflation stabilizes at 2.2% in April as energy prices fall but services inflation spikes. Annual headline inflation in the EA remained unchanged at 2.2% in April. Though energy prices declined sharply year-on-year (-3.5%), they were offset by a spike in services inflation (+3.9% y/y) primarily due to one-off factors (seasonal effects) linked to the Easter holidays. Food prices also increased, from 2.9% to 3%, while annual goods inflation remained unchanged at 0.6%. Looking ahead, while inflation remains close to the ECB’s 2% target, the near-term outlook continues to be uncertain following April’s tariff shock. On one hand, escalating US-China trade tensions could prompt the latter to reroute some of its excess capacity toward Europe, exerting downward pressure on prices. Lower energy costs and softer demand expectations may also contribute to weaker inflation. On the other hand, failure to secure a trade agreement between Europe and the US - or the threat of retaliatory measures – could drive prices higher. We expect more clarity on how price pressures will unfold in the short term as the 90-day tariff pause nears its end. As a result, we leave our inflation forecasts unchanged from last month, still projecting overall inflation in the EA to average 2.1% in 2025 before easing to 1.9% in 2026, while core inflation is projected to average 2.3% and 1.9% in 2025 and 2026, respectively.
Weak growth prospects in Q2 and protracted uncertainty pave the way for a June cut. On April 17th, the European Central Bank (ECB) lowered its key rates by 25 basis points (bp), bringing its main policy rate (i.e., deposit) to 2.25%. In the press conference that followed, there was a shift in focus from inflation to concerns about the EA’s weak growth prospects. Given that latest data reinforce these fears, we now expect the ECB to ease further its deposit rate in June – almost certainly by another 25 bp. Beyond June, however, predicting the ECB’s next move is more complicated. On the one hand, disinflationary pressures are already mounting in the region, which would in principal prevent the ECB from easing further. But if growth prospects continue to deteriorate on the other, the bank will have to apply even more accommodative policies. We await more information to understand how the balance of arguments will play out and make no changes to our monetary policy forecasts. We still project one more cut in June and then a pause at 2% for the remainder of the year. However, incoming data over the second quarter will be critical on whether we lower further our rate expectations – and bring it closer to market expectations - especially if new figures point to a further weakening in the economy.
Despite signs of slowdown, the labor market remains robust. Latest labor market data continues to indicate a solid and resilient jobs environment in the Euro Area. Despite weaker economic activity, unemployment rate remained unchanged in March at the all-time low of 6.2% and timelier employment data even showed the region continued to add workers in the last quarter of 2024. More recently, signs of the labor market cooling have continued to build. Job vacancies are falling fast to their pre-pandemic levels and hiring intentions in key sectors like manufacturing and construction have become less favorable. Nevertheless, we still expect the EA labor market to retain its positive outlook in the near-term, also due to the limited impact the US tariffs are likely to have on unemployment within the forecast horizon.
Policy uncertainty continues to be exceptionally high while we are monitoring pockets of conflicts erupting globally. We identify three issues to watch next.
- Europe prepares a €100 billion retaliatory package against the US if trade talks fail. The European Union is working towards a set of countermeasures that could hit approximately 100 billion euros worth of US goods according to latest reports by Bloomberg. For now, details are scarce. The package is only designed to be used if trade talks fail and the US administration applies the 20% ‘reciprocal’ tariff on EU exports. In the meantime, and in an effort to ease trade tensions, the EU has offered to purchase more US goods (e.g., agricultural products or liquified natural gas), eliminate all tariffs on industrial goods (including cars) and even offered the possibility of increasing investments in the US. For the moment, tariffs in place include those on EU cars, steel and aluminum as well as a 10% blanket tariff on all EU-produced goods entering the US. Assuming trade talks fail, and EU’s countermeasures come into effect, a full-fledged trade war with the US would be inevitable, an outcome which would put even greater pressure on EA’s already fragile economy.
- Romania’s first round of elections point to a nationalist outcome. George Simion, a right-wing nationalist candidate, won comfortably the first round of presidential elections on May 4th against Bucharest’s liberal mayor Nicusor Dan. Simion secured around 41% of the vote, winning in 36 out of 41 cities in Romania and receiving overwhelming support from Romanians living abroad. A vocal Eurosceptic, an open supporter of Donald Trump and a keen opposer of any military aid to neighboring Ukraine, a potential Simion victory would have far-reaching implications for Romania’s future. At the EU-level, it adds another country to the list of those that obstruct EU decision making. As a small country, however, this is not expected to be a real obstacle.
- From Europe to the Middle East and South India, conflicts flare up. Prospects of an all-out war between Pakistan and India have increased more recently, following a week-long military exchange between the two countries. In the Middle East, a potential new Israeli offensive against the Palestinians threatens to throw the region into even deeper turmoil and humanitarian crisis. On top of that, fresh Israeli attacks on Houthi targets in Yemen have raised the risk of a broadened military conflict in the Arabian Peninsula. This already adds to a turbulent world economy that is unable to cooperate to guarantee peace.
For more resources on the European economy, please see our monthly Economy Watch report and annual long-term outlook (December 2024).
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