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The author is a monetary journalist and writes the Wealth of Nations e-newsletter
As 2024 attracts to an finish, it’s laborious to be optimistic about Europe. Its politics turn into ever extra fragmented and polarised. Germany could also be with no secure authorities till at the least after elections in late February, France might have to attend till 2027 when President Emmanuel Macron’s time period ends.
Development has stalled, unemployment is predicted to rise. The economic system has been held again by burdensome regulation, excessive vitality costs, weak demographics, rising competitors in manufacturing sectors and a failure to maintain tempo with Chinese language and American technological advances. A lot of the continent is grappling with extreme debt at the same time as governments are underneath stress to ship massive will increase in defence spending.
The consensus forecast is for progress of simply 1.1 per cent subsequent 12 months. Some are even gloomier: Financial institution of America expects progress of simply 0.9 per cent in 2025. Even this assumes that Donald Trump imposes solely modest tariffs on Europe on his return to the White Home. Dangers to progress are overwhelmingly to the draw back, in response to the newest European Central Financial institution survey of impartial economists.
This pessimism is mirrored in markets. European shares could also be buying and selling at near file highs however they’ve sharply underperformed US equities. The Euro Stoxx 600 index now trades at a file 40 per cent discount to the S&P 500 index primarily based on subsequent 12 months’s forecast earnings. Whereas US households have by no means been extra optimistic about shares and US fund managers have by no means held much less money, international fund managers are underweight European equities and nobody expects them to outperform different markets in 2025, in response to the latest Bank of America survey of traders.
But a lot pessimism additionally units a really low bar for upside surprises. What might go proper in Europe in 2025 that would carry the temper? A number of issues spring to thoughts.
Probably the most rapid is that the ECB stops worrying about inflation and strikes decisively to assist progress. Reducing its benchmark rate of interest to 1.5 per cent or beneath from the present 3.0 per cent might assist revive confidence in sectors which have been struggling, together with actual property and development, reckons Gilles Moëc, group chief economist at Axa. It could additionally assist decarbonisation initiatives that run on very long time horizons and ease a number of the fiscal stress on governments.
Second, an early finish to the warfare in Ukraine on phrases that Kyiv might settle for would take away one of many darkest clouds which have hung over the continental economic system over the previous two and a half years, notably if it led to decrease vitality costs. The rebuilding of Ukraine and its integration into the EU single market would stimulate financial exercise. That will be a gradual course of however the increase to confidence can be rapid. Such a deal could seem unlikely now, however current occasions in Syria are a reminder at how shortly the wheel of geopolitical fortune can flip.
One other increase might come through leisure of Germany’s debt brake. Friedrich Merz, the frontrunner to be the nation’s subsequent chancellor, might at present be ruling this out, at the least till the election. However it’s laborious to sq. his Christian Democratic Union get together’s dedication to extend defence spending and lower taxes with out extra borrowing. With everybody from Angela Merkel to the present president of the Bundesbank now throwing their weight behind reform of the debt brake, looser fiscal coverage appears doubtless. In the meantime, a decided programme of supply-side reforms might carry German progress by as much as 0.5 share factors subsequent 12 months, reckons Holger Schmieding, chief economist of Berenberg Financial institution.
An additional upside shock could possibly be progress in implementing Mario Draghi’s current suggestions on the way to increase the EU’s competitiveness. Expectations are at present low, not least due to opposition to any contemporary issuance of frequent debt. But a lot of the previous Italian prime minister’s deregulatory agenda doesn’t require further funding and even laws. Moreover, there are indicators that resistance to new debt issuance to fund defence spending could also be weakening as Europe scrambles to offer for its personal safety and forestall Trump’s tariff threats.
Some argue that progress on reform is unlikely as a result of Europe lacks robust management, notably in France and Germany. But others are filling the void. Ursula von der Leyen’s resolution to fly to Brazil within the first week of her new mandate to signal the EU-Mercosur commerce settlement, for instance, confirmed that the European Fee president is unafraid to take political dangers in pursuit of a deal that’s patently within the bloc’s financial and geopolitical curiosity. She at the least appears to recognise the gravity of the second — and is ready to rise to it. Maybe 2025 would be the 12 months when Europe positively surprises us.
