Upward revisions to Q1 growth figures must not mask the EA’s challenges ahead. Revised GDP growth estimates for Q1 delivered positive surprises across key EA economies in May. Germany came up to 0.4%, double the initial flash estimate. Italy also outperformed expectations, expanding by 0.3% quarter-on-quarter (q/q), up from 0.1% originally expected. Export front-loading in manufacturing was the main driver in both countries, as firms rushed to avoid tariffs. However, private investment and consumption also contributed positively to growth. Growth figures for France and Spain remained unchanged at 0.1% (q/q) and 0.6% (q/q), respectively. Can the EA sustain this growth momentum? The picture remains mixed. Latest surveys show that manufacturing activity will maintain its strong momentum in Q2, as both firms and consumers continue to stockpile on goods in fear of future tariffs. Yet, the outlook for the more dominant services sector is less encouraging. Services activity in the EA decelerated in May further according to latest PMI data, demand expectations continued to soften, and there was also a notable drop in services inflation. In short, robust manufacturing activity will not be enough to sustain Q1’s strong growth momentum. Unless services activity also rebounds, the EA is likely to see growth moderating again in Q2. The outcome of the EU-US trade talks in early July will also affect the region’s economic prospects into 2025 and beyond. Summing up, while the upward revisions to Q1 growth have led us to raise our 2025 GDP forecast for 2025 slightly, from 0.9% to 1.0%, we make no changes to our subsequent quarterly growth projections for both 2025 and 2026, as uncertainty remains elevated and services growth remains a question mark.
Inflation falls more than expected in May. Overall year-on-year inflation in the EA declined from 2.2% in April to 1.9% in May, below the ECB’s 2% target. Core inflation, which excludes the more volatile items of energy and food, also eased to 2.3%, its lowest level since November 2022. Food prices increased on a year-on-year basis, accelerating from 3.0% to 3.3%. Annual goods inflation edged up slightly, to 0.6%, while energy prices fell by 3.6% compared to a year earlier. Alongside energy, a steep deceleration in services inflation played a key role in easing overall price pressures in May, with yearly services price growth falling from 3.6% a month ago to 3.2%. Looking ahead, the inflation outlook remains uncertain as both upward and downward pressures remain. Failure to secure a trade agreement between Europe and the US by the July 9 deadline could trigger a full-scale trade war between two. Both the lack of clarity and trade wars will produce upward pressures on inflation and damage growth prospects. However, escalating trade frictions between China and the US creates the possibility of redirecting Chinese excess capacity towards European market that would put downward pressure on inflation. We expect greater clarity on the trajectory of inflation as the 90-day tariff truce approaches its expiration. As such, we do not changer our inflation assumptions, with small downward revisions stemming only from the higher-than-expected decline in May’s figures. As a result, we now project headline inflation in the euro area to average 2.0% in 2025, before easing to 1.8% in 2026. Core inflation is expected to average 2.3% in 2025, moderating to 1.8% in 2026.
May inflation data seals the case for a June rate cut. With headline inflation now below the ECB’s 2% objective, a quarter-point cut at the early June meeting is all but certain. In that case, this marks the fourth 25-basis points (bp) cut in 2025, bringing the deposit rate at 2.00% - its lowest value in nearly three years. The ECB’s next meeting is scheduled for July 24, after the US administration’s 90-day tariff truce expires.. For now, the combination of easing inflation, slower wage growth, a cooling labor market, an appreciating euro, and cheaper energy prices all support the case for continued disinflation in the Euro Area – and thus, potentially future rate cuts by the ECB. However, a breakdown in the EU-US trade could reintroduce upward pressure on inflation, either directly (e.g., higher import prices) or indirectly (e.g., through costlier supply chain disruptions). Given this level of uncertainty, we leave our monetary policy forecasts unchanged for the remainder of the year. We will monitor incoming data regarding economic activity in Q2 and the evolution of the EU-US (and US-China) trade relations very carefully as they will affect possible revisions we make to our rate path.
Strong Q1 employment growth and record-low unemployment suggest the labor market will remain resilient in the year ahead. Despite subdued economic activity in recent quarters, employment growth in the EA exceeded expectations in Q1, rising by 0.3% q/q. The unemployment rate in the region held steady at the record-low of 6.2%. Timelier soft data show that the labor market’s resilience will continue in the short term, even as signs of cooling accumulate. For instance, employment expectations, while marginally lower throughout 2024 and early 2025, showed slight improvement in April and May. Meanwhile, job vacancies also remain plentiful despite falling below their pre-COVID levels in key European markets. Simultaneously, a growing share of companies report no plans to reduce their headcount, even if they anticipate demand to remain weak in the near term. Taken together, latest data confirm our expectations that the EA’s labor market will retain its robust outlook in 2025 and 2026, mitigating the adverse effects of economic uncertainty. We continue to expect that short-term resilience in European labor markets come with long-term risks, as it becomes less and less possible for firms to continue to hoard.
There is a mix of upside and downside risks that may be economically significant for the EA both in the short and long term:
- Higher Q1 growth in the EA was not solely driven by one-off factors. Better-than-anticipated growth rates in Q1 for key EA economies like Germany and Italy was not only because of temporary factors like front-loading of exports to the US or consumers rushing to buy goods before tariffs kick in. Private investments, as captured by the gross fixed capital formation component of the expenditure-based GDP data, also had a significant, and in some cases growing, role in supporting economic activity. In Germany, investments’ contribution to GDP grew q/q at the highest rate since Q1 2024, by 0.2 percentage points (pp). Italy posted an even stronger increase of 0.34 pp, while in Spain investment growth came in at 0.23pp. It’s still soon to tell whether this trend will endure. However, both the pressures on increasing defense spending and the need for greater economic sovereignty have created a momentum for domestic investments.
- The Conference Board’s CEO Confidence Index declines globally. In late May to early June, The Conference Board published its CEO Confidence survey for Europe and the US. Amid trade uncertainty and ongoing geopolitical tensions, global CEO confidence dropped significantly in all three key regions (China, the US, and Europe), with the US and Europe seeing the largest declines. In the US, confidence fell to its lowest level since Q4 2022, primarily driven by worsening views on current economic conditions and industry prospects. More than 80% of US CEOs expect a recession in the next 12 to 18 months. China-based CEOs also expressed pessimism about future economic and industry conditions.
- Political risks increase following events in the Netherlands and Poland. Following France and Romania, political developments in Poland and the Netherlands come to add in a long list of political disruptions in Europe. In the Netherlands, the four-party coalition government collapsed after Geert Wilder, far-right PVV’s leader, withdrew his party support over alleged disagreements on asylum policies. This comes just three weeks ahead of the NATO summit, scheduled for 24-25 June in the Hague. Elections are now expected in autumn but the deep fragmentation in the Dutch parliament point to prolonged political uncertainty at a time when the economy is weakening. In Poland, Euroskeptic Nawrocki’s close victory as the country’s new President poses new challenges to Prime Minister Donald Tusk’s pro-EU agenda given the president’s veto power. In turn, Tusk has requested a vote of confidence to be held on June 11. Also, Nawrocki’s opposition to Ukraine’s NATO membership may strain Poland’s relationships with Brussels and undermine EU’s efforts to achieve cohesive policies on strategic issues such as defense.
Upward revisions to Q1 growth figures must not mask the EA’s challenges ahead. Revised GDP growth estimates for Q1 delivered positive surprises across key EA economies in May. Germany came up to 0.4%, double the initial flash estimate. Italy also outperformed expectations, expanding by 0.3% quarter-on-quarter (q/q), up from 0.1% originally expected. Export front-loading in manufacturing was the main driver in both countries, as firms rushed to avoid tariffs. However, private investment and consumption also contributed positively to growth. Growth figures for France and Spain remained unchanged at 0.1% (q/q) and 0.6% (q/q), respectively. Can the EA sustain this growth momentum? The picture remains mixed. Latest surveys show that manufacturing activity will maintain its strong momentum in Q2, as both firms and consumers continue to stockpile on goods in fear of future tariffs. Yet, the outlook for the more dominant services sector is less encouraging. Services activity in the EA decelerated in May further according to latest PMI data, demand expectations continued to soften, and there was also a notable drop in services inflation. In short, robust manufacturing activity will not be enough to sustain Q1’s strong growth momentum. Unless services activity also rebounds, the EA is likely to see growth moderating again in Q2. The outcome of the EU-US trade talks in early July will also affect the region’s economic prospects into 2025 and beyond. Summing up, while the upward revisions to Q1 growth have led us to raise our 2025 GDP forecast for 2025 slightly, from 0.9% to 1.0%, we make no changes to our subsequent quarterly growth projections for both 2025 and 2026, as uncertainty remains elevated and services growth remains a question mark.
Inflation falls more than expected in May. Overall year-on-year inflation in the EA declined from 2.2% in April to 1.9% in May, below the ECB’s 2% target. Core inflation, which excludes the more volatile items of energy and food, also eased to 2.3%, its lowest level since November 2022. Food prices increased on a year-on-year basis, accelerating from 3.0% to 3.3%. Annual goods inflation edged up slightly, to 0.6%, while energy prices fell by 3.6% compared to a year earlier. Alongside energy, a steep deceleration in services inflation played a key role in easing overall price pressures in May, with yearly services price growth falling from 3.6% a month ago to 3.2%. Looking ahead, the inflation outlook remains uncertain as both upward and downward pressures remain. Failure to secure a trade agreement between Europe and the US by the July 9 deadline could trigger a full-scale trade war between two. Both the lack of clarity and trade wars will produce upward pressures on inflation and damage growth prospects. However, escalating trade frictions between China and the US creates the possibility of redirecting Chinese excess capacity towards European market that would put downward pressure on inflation. We expect greater clarity on the trajectory of inflation as the 90-day tariff truce approaches its expiration. As such, we do not changer our inflation assumptions, with small downward revisions stemming only from the higher-than-expected decline in May’s figures. As a result, we now project headline inflation in the euro area to average 2.0% in 2025, before easing to 1.8% in 2026. Core inflation is expected to average 2.3% in 2025, moderating to 1.8% in 2026.
May inflation data seals the case for a June rate cut. With headline inflation now below the ECB’s 2% objective, a quarter-point cut at the early June meeting is all but certain. In that case, this marks the fourth 25-basis points (bp) cut in 2025, bringing the deposit rate at 2.00% - its lowest value in nearly three years. The ECB’s next meeting is scheduled for July 24, after the US administration’s 90-day tariff truce expires.. For now, the combination of easing inflation, slower wage growth, a cooling labor market, an appreciating euro, and cheaper energy prices all support the case for continued disinflation in the Euro Area – and thus, potentially future rate cuts by the ECB. However, a breakdown in the EU-US trade could reintroduce upward pressure on inflation, either directly (e.g., higher import prices) or indirectly (e.g., through costlier supply chain disruptions). Given this level of uncertainty, we leave our monetary policy forecasts unchanged for the remainder of the year. We will monitor incoming data regarding economic activity in Q2 and the evolution of the EU-US (and US-China) trade relations very carefully as they will affect possible revisions we make to our rate path.
Strong Q1 employment growth and record-low unemployment suggest the labor market will remain resilient in the year ahead. Despite subdued economic activity in recent quarters, employment growth in the EA exceeded expectations in Q1, rising by 0.3% q/q. The unemployment rate in the region held steady at the record-low of 6.2%. Timelier soft data show that the labor market’s resilience will continue in the short term, even as signs of cooling accumulate. For instance, employment expectations, while marginally lower throughout 2024 and early 2025, showed slight improvement in April and May. Meanwhile, job vacancies also remain plentiful despite falling below their pre-COVID levels in key European markets. Simultaneously, a growing share of companies report no plans to reduce their headcount, even if they anticipate demand to remain weak in the near term. Taken together, latest data confirm our expectations that the EA’s labor market will retain its robust outlook in 2025 and 2026, mitigating the adverse effects of economic uncertainty. We continue to expect that short-term resilience in European labor markets come with long-term risks, as it becomes less and less possible for firms to continue to hoard.
There is a mix of upside and downside risks that may be economically significant for the EA both in the short and long term:
- Higher Q1 growth in the EA was not solely driven by one-off factors. Better-than-anticipated growth rates in Q1 for key EA economies like Germany and Italy was not only because of temporary factors like front-loading of exports to the US or consumers rushing to buy goods before tariffs kick in. Private investments, as captured by the gross fixed capital formation component of the expenditure-based GDP data, also had a significant, and in some cases growing, role in supporting economic activity. In Germany, investments’ contribution to GDP grew q/q at the highest rate since Q1 2024, by 0.2 percentage points (pp). Italy posted an even stronger increase of 0.34 pp, while in Spain investment growth came in at 0.23pp. It’s still soon to tell whether this trend will endure. However, both the pressures on increasing defense spending and the need for greater economic sovereignty have created a momentum for domestic investments.
- The Conference Board’s CEO Confidence Index declines globally. In late May to early June, The Conference Board published its CEO Confidence survey for Europe and the US. Amid trade uncertainty and ongoing geopolitical tensions, global CEO confidence dropped significantly in all three key regions (China, the US, and Europe), with the US and Europe seeing the largest declines. In the US, confidence fell to its lowest level since Q4 2022, primarily driven by worsening views on current economic conditions and industry prospects. More than 80% of US CEOs expect a recession in the next 12 to 18 months. China-based CEOs also expressed pessimism about future economic and industry conditions.
- Political risks increase following events in the Netherlands and Poland. Following France and Romania, political developments in Poland and the Netherlands come to add in a long list of political disruptions in Europe. In the Netherlands, the four-party coalition government collapsed after Geert Wilder, far-right PVV’s leader, withdrew his party support over alleged disagreements on asylum policies. This comes just three weeks ahead of the NATO summit, scheduled for 24-25 June in the Hague. Elections are now expected in autumn but the deep fragmentation in the Dutch parliament point to prolonged political uncertainty at a time when the economy is weakening. In Poland, Euroskeptic Nawrocki’s close victory as the country’s new President poses new challenges to Prime Minister Donald Tusk’s pro-EU agenda given the president’s veto power. In turn, Tusk has requested a vote of confidence to be held on June 11. Also, Nawrocki’s opposition to Ukraine’s NATO membership may strain Poland’s relationships with Brussels and undermine EU’s efforts to achieve cohesive policies on strategic issues such as defense.
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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