German Chancellor Olaf Scholz welcomes French President Emmanuel Macron before a private dinner at the “Kochzimmer” restaurant in Potsdam, outside Berlin, Germany, June 6, 2023.
Michael Kappeler | Swimming pool | via Reuters
The past year has been a tumultuous year for the euro zone, with its largest economies, Germany and France, seeing political and economic turmoil that means neither has a budget set for 2025.
Economists say the trajectory of both countries is worrying and warn that lack of growth, fiscal imbalances and political intransigence could lead to decline and a loss of prestige for Europe as a whole.
“The current situation is different from before. (sovereign debt) disaster to the extent that Europe’s most serious problems are no longer concentrated in smaller economies like Greece. Instead, it is Europe’s two largest economies that are struggling,” Neil Shearing, chief economist at the Capital Economics group, said in an analysis in December.
“Europe faces continued decline without basic reform at its core,” Shearing said, noting that if this is not carried out, “it is difficult to escape the conclusion that Europe’s future is one of very low growth, continued concerns about fiscal sustainability and a diminishing sense of position in a world increasingly characterized by a superpower rivalry between the United States and China.”
As things stand, neither France nor Germany have a 2025 budget amid political infighting that ultimately brought down their governments.
New elections will be held in Germany in February and analysts are betting on new parliamentary elections in France next summer. The countries are now operating on interim budgets, after extending their tax and spending provisions from 2024 to this year, and it is unclear when any of them will agree on a 2025 budget.
France and Germany face different economic challenges, reflecting both the dangers of overspending and underspending.
France had a budget deficit estimated at 6.1% and debt estimated at 112% in 2024, according to the IMF. Prime Minister Francois Bayrou’s new government is expected to struggle to get warring MPs from all sides to approve a 2025 budget, just as his predecessor Michel Barnier did.
Meanwhile, Germany faces a snap federal election in February after Chancellor Olaf Scholz’s governing coalition collapsed in the fall over divisions over economic and budget policies. Germany’s problem is underspending and underinvestment that have led to declining economic growth.
“By contrast, Germany’s problem is overly tight fiscal policy,” said Capital Economics’ Shearing.
“His so-called “debt brake” significantly reduces the scope for deficit spending even though the German public debt burden is low. With a stagnant economy, Germany would benefit from a more flexible fiscal policy, and since this would almost certainly absorb imports from other countries “This would help support growth (and therefore fiscal consolidation) in France and Italy” , he pointed out.
Need to focus on growth
Economists say the lack of budget plans means Europe’s major economies will not be able to focus fully on policies aimed at economic expansion, continuing a worrying trend of anemic growth in recent years.
This has been caused by a confluence of events, such as the war in Ukraine and rising energy prices, an issue that has affected energy-intensive industries in Europe, but which has also been exacerbated by a weaker demand, both in terms of external demand such as from countries such as China and weaker consumer demand within Europe, as well as deeper structural problems such as low productivity growth and a lack of competitiveness.
The European Central Bank has sought to boost economic activity in the euro zone cutting interest rates, implementing a 25 basis point reduction in December (its fourth cut this year) to bring its key rate to 3%. The central bank said it expected the euro zone economy to post growth of 0.7% in 2024 and 1.1% in 2025. Inflation in the bloc was estimated at 2.4% in 2024 and 2 .1% this year.
Risks to economic growth “remain tilted to the downside,” ECB President Christine Lagarde said at a press conference in December, warning of the potential for “further frictions in global trade” and that “lower confidence “It could prevent consumption and investment from recovering so quickly.” as expected.”
Some analysts, such as Kallum Pickering, chief economist at Peel Hunt, told CNBC that the ECB should be bolder and seek further rate cuts in 2025.
Others say rate cuts can’t help fix structural problems, such as low productivity growthand obstacles such as possible tariffs on European imports bound for the United States, which will likely be introduced by US President-elect Donald Trump.
“Our base case is that Europe will face a fairly difficult year in 2025,” Jari Stehn, chief European economist at Goldman Sachs, told CNBC, with the investment bank forecasting 0.8% growth for the euro zone in 2025. , compared to 2.5% for the eurozone. United States, during the same period.
“There are a lot of problems… high energy prices, the slowdown in China, political uncertainty, trade tensions are all negative things,” he told CNBC’s “Squawk Field Europe.” However, investors were still looking for potential bright spots in the region.
“People are wondering if in Germany, when there are new elections, we could get more fiscal support; maybe we think there will be something, but we think ultimately it will be limited,” Stehn said.
“People are also wondering if the European consumer could finally be positively surprised. The savings rate is high, there is actually quite a bit of money. (that could be spent) but again we think there will be some support, although a big upside surprise is unlikely.”
Stehn noted that lower interest rates “will go some way to helping consumers save and increase spending, and that’s one of the reasons we really think Europe will grow next year, despite these challenges.”
“But at the same time, I think we also have to be realistic that a lot of the headwinds that we’ve talked about (such as) Energy prices, China, structural issues. Cutting rates will not solve all those things,” he said.
“Ultimately, it will be a challenging environment.”
