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FT editor Roula Khalaf selects her favorite stories in this weekly newsletter.
The writer is a financial journalist. and writes the newsletter The Wealth of Nations
As 2024 draws to a close, it is difficult to be optimistic about Europe. Its politics are becoming increasingly fragmented and polarized. Germany could be left without a stable government at least until after elections at the end of February, and France could have to wait until 2027, when President Emmanuel Macron’s term ends.
Growth has stagnated and 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 an inability 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 make big increases in defense spending.
The consensus forecast is for growth of just 1.1 percent next year. Some are even more pessimistic: Bank of America expects growth of just 0.9 percent in 2025. Even this assumes Donald Trump imposes only modest tariffs on Europe when he returns to the White House. The risks to growth are overwhelmingly to the downside, according to the European Central Bank’s latest survey of independent economists.
This pessimism is reflected in the markets. European stocks may be trading near all-time highs, but they have significantly underperformed U.S. stocks. The Euro Stoxx 600 index is now trading at a record 40 percent discount to the S&P 500 index based on expected earnings for the next year. While American households have never been more optimistic about stocks and American fund managers have never had less cash, global fund managers are underweight European stocks and no one expects them to outperform other markets in 2025, according to the latest Bank of America survey of investors.
However, such pessimism also leaves the bar very low for bullish surprises. What could go right in Europe in 2025 that could lift spirits? Several things come to mind.
The most immediate is for the ECB to stop worrying about inflation and act decisively to support growth. Cutting its benchmark interest rate to 1.5 percent or less from the current 3.0 percent could help revive confidence in sectors that have been struggling, including real estate and construction, says Gilles Moëc, chief economist. of the Axa group. It would also support decarbonization projects that are implemented with long time horizons and relieve some of the fiscal pressure on governments.
Second, an early end to the war in Ukraine on terms kyiv could accept would remove one of the darkest clouds that has hung over the continental economy for the past two and a half years, particularly if it led to lower commodity prices. energy. Reconstruction of Ukraine and its integration into the EU single market would stimulate economic activity. It would be a gradual process, but the boost to confidence would be immediate. Such an agreement may seem unlikely now, but recent events in Syria are a reminder of how quickly the wheel of geopolitical fortune can turn.
Another boost could come from the easing of Germany’s debt brake. Friedrich Merz, the favorite to be the country’s next chancellor, may rule out this possibility for the moment, at least until the elections. But it is difficult to meet his party’s commitment, the Christian Democratic Union, to increase defense spending and reduce taxes without more borrowing. Now that everyone from Angela Merkel to the current Bundesbank president supports debt brake reform, more flexible fiscal policy seems likely. Meanwhile, a determined program of supply-side reforms could boost German growth by up to 0.5 percentage points next year, estimates Holger Schmieding, chief economist at Berenberg Bank.
Another positive surprise could be progress in implementing Mario Draghi’s recent recommendations on how to boost the EU’s competitiveness. Currently expectations are low, especially due to opposition to any new issuance of common debt. However, much of the former Italian prime minister’s deregulatory agenda does not require additional funding or even legislation. Furthermore, there are signs that resistance to new debt issuance to finance defense spending may be weakening as Europe struggles to ensure its own security and prevent Trump’s tariff threats.
Some argue that progress on reforms is unlikely because Europe lacks strong leadership, particularly in France and Germany. However, 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 president of the European Commission is not afraid to take political risks in pursuit of a agreement that is clearly in the economic and geopolitical interests of the bloc. She at least seems to recognize the gravity of the moment and is willing to rise to the occasion. Perhaps 2025 will be the year in which Europe positively surprises us.