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Economic Outlook Eurozone Q3 2024: Growth Returns, Rates Fall


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Economic Outlook Eurozone Q3 2024: Growth Returns, Rates Fall

S&P Global Ratings expects GDP growth to accelerate from 0.7% this year to 1.4% next year, up from 1.3% in our March forecasts, as lower commodities prices, especially energy prices, allow terms of trade to rebalance, disinflation to continue, and real incomes to recover.

Barring any significant new shock, the 2% inflation target seems to be in reach and likely to occur by mid-2025, as a rebound in productivity, moderation in profit margins, and slower wage growth will bring core inflation down further. We expect inflation to recede to 2.2% in 2025, from 2.4% this year and 5.4% in 2023. This compares with 2.6% and 2.1%, respectively, in our previous forecasts from March 2024.

Although marginal, the upward revision of our inflation forecast for 2025 despite a lower projection for 2024 reflects a slower appreciation of the euro-to-dollar exchange rate than we had anticipated. This is due to the U.S. Fed's postponement of the first cut in the funds rate to December 2024 and the volatility stemming from political uncertainties in Europe. That said, a return of the euro to fair value against the dollar remains our baseline expectation, since we expect GDP growth and policy rates to converge on both sides of the Atlantic over 2024-2026 (see chart 1).

With growth likely to return to its potential over the next 12 months, and inflation moving back toward the target, we continue to forecast a quarterly cut in ECB rates until the deposit rate bottoms out at 2.5% in the third quarter of 2025. This compares to 3.75% currently. We believe that by then, monetary policy will have ceased to be restrictive, but will not be expansionary.

Finally, we have revised our unemployment rate forecasts to 6.5% for this year and next, from 6.6% for both years previously, as the labor market continues to prove more resilient than we thought.

Chart 1


More Favorable Terms Of Trade Returned The Eurozone Economy To Growth At The Start Of The Year

The soft landing of the economy we were expecting has largely materialized. After five quarters of quasi-stagnation, and even a slight contraction at the end of 2023, eurozone GDP finally rose by a robust 0.3% in the first three months of 2024, thanks to net exports, private consumption, and construction, while business investment and inventories were still a drag.

Admittedly, a mild end to the winter of 2023-2024 may have influenced the rebound in construction, and it might revert in the second quarter of 2024. However, the return to growth in Europe is mainly due to a sustained recovery in the terms of trade linked to the fall in energy prices (see chart 2). This is allowing:

  • Inflation to recede;
  • Lending rates to fall from their peak as a consequence of receding inflating; and
  • Consumer, business, and investor confidence to recover thanks to the previous two factors.

The resilience of the European labor market, with unemployment rates in most countries close to or at historical lows (see chart 3), is another reason for the European economy returning to growth and confidence improving.

Chart 2


Chart 3


Economic Activity Will Continue To Increase In The Rest Of The Year

Wages are growing faster than consumer prices, by 5.0% year on year in the first quarter of 2024 in terms of compensation per employee, compared to 2.9% year on year for the consumption deflator. Even if the wage agreements in place for 2025 point to a deceleration in wage growth compared to this year, inflation will be lower than wage growth. This means that households should continue to regain the purchasing power they lost during the energy crisis.

Although job vacancies have peaked, they are still plentiful, representing 3% of the workforce in the first quarter of 2024. This level of vacancies is still too high to push up the unemployment rate. What's more, households have not yet benefited much from the fall in gas prices, particularly in Germany (see chart 4). The benefits should be more evident by the end of the year, when operators and tax authorities normally adjust retail power and gas tariffs to wholesale market prices. That said, operators and tax authorities may be tempted not to pass on all the wholesale price cuts to consumers in order to absorb the network costs that can accompany the energy transition.

In addition, lending rates should continue to fall thanks to easing monetary policy. This should benefit investment, especially in the housing sector. According to the latest ECB bank lending survey, eurozone banks anticipate a substantial increase in demand for housing loans in the second quarter of this year, without any additional tightening of credit standards for these loans. Overall, domestic demand should continue to strengthen, first through consumer spending from the second half of 2024, and then through investment from 2025. This will enable a return to potential GDP growth. That said, potential growth is lower for the eurozone (between 1.0% and 1.5%) than for the U.S. (between 2.0% and 2.5%).

Chart 4


Spain Outperforming Germany Is Not Just A Case Of Tourism Outperforming Industry

Lower energy costs helped the German economy to emerge from recession in the first quarter of 2024, thanks to a recovery in production in energy-intensive sectors such as the chemicals industry. However, the German economy still lags other large European economies in terms of growth. Spain, noticeably, continues to beat expectations, with GDP growth accelerating for the third consecutive quarter to 0.7% quarter on quarter (see chart 5).

The post-pandemic normalization of tourism is not the only reason for this. Industrial production is continuously expanding in Spain. Last year, consumer spending was the main driver of growth, adding one percentage point of a 2.5 percentage-point increase in Spain's GDP (see chart 6). The earlier and sharper fall in energy prices than in the eurozone's other major economies, supported by government measures, partly explains the stronger recovery in consumer spending.

Second-round effects on core inflation have also been more muted in Spain than in many other countries. Stronger employment growth, stimulated by labor market reforms aimed at replacing limited-term employment contracts with open-ended ones, is another explanation. The dynamism in employment does not hinder productivity growth, in contrast to the other three major economies of the eurozone, Germany, France, and Italy.

What's more, Spanish households have deleveraged and are now no more indebted than their German counterparts, with a debt-to-income ratio of 85% versus 128% in 2012. Spanish households have also made significant changes to their mortgage financing, switching from their traditional variable rates to fixed rates, which makes them less sensitive to monetary policy than in the past. Their savings rate is now back to 2019 levels, while French and German households are still saving more than before the pandemic.

Chart 5


Chart 6


Further Disinflation Is Unlikely To Proceed Smoothly, Prompting The ECB To Remain Cautious About Cutting Rates

While inflation fell steadily to 2.4% in April 2024 from a peak of 10.6% in October 2023, it rebounded by 20 basis points in May 2024 to reach 2.6% in the headline index and 2.9% in the core index. This rebound was widely expected, mainly owing to base effects relating to government support for domestic energy prices and public transport in some countries. But May's rebound illustrates how long it will take for inflation to return to the 2% target.

Most of the base effects on energy and food prices that caused the ups and downs of this inflationary wave are behind us. Second-round effects, namely wages, are now causing inflation, and it will not be until productivity recovers and/or profit margins narrow that inflation will recede further. Given the slow decline in wage growth (see chart 7), this alignment of the planets is unlikely to occur before mid-2025. In the meantime, we expect inflation to hover around 2.5%.

Chart 7


In this context, we expect the ECB to adopt a cautious stance, waiting for confirmation of inflation--especially core inflation--from hard wage data and staff projections before deciding on further rate cuts (see chart 8). This is the reason for cutting rates at the end of each quarter, when wage data and staff projections are updated, until inflation lands on target and growth is back to a steady state, which should be the case around the third quarter of 2025. Such an approach would leave room for five more rate cuts, a cumulative 125 bps, after the first cut of 25 bps in June 2024.

Chart 8


The Risks Of Weaker Growth, Higher Inflation, And Tight Financial Conditions Have Intensified Since March 2024

The geopolitical conflicts in the Middle East and Ukraine remain the main risks weighing on our immediate economic outlook (see "Credit Conditions Europe Q2 2024: Credit Heals, Defense Shields," published on March 27, 2024). That aside, other pockets of risks have intensified in recent months. These concern the decoupling of monetary policies on both sides of the Atlantic, political uncertainty in Europe, and the worsening of Europe's economic relations with China.

Monetary policy decoupling

Whereas three months ago, we expected the Fed to start its rate-cutting cycle in the summer of 2024, with little lag behind the ECB's rate-cutting cycle, we now anticipate the first Fed rate cut in December 2024. The lag could affect the euro-to-dollar exchange rate, which we have reflected in our forecasts by delaying the likely appreciation of the euro. Aside from this, the lag could lead to a rise in long-term yields in Europe, counteracting ECB rate cuts, and delaying or even undermining the recovery in investment that we forecast for 2025 in our base case.

Eurozone investors are arguably the main foreign investors in U.S. Treasury securities (see chart 9). Admittedly, China using custodian services located in the euro area to recycle parts of its foreign-exchange reserves in U.S. assets somewhat blurs the line. That said, over the first three months of the year, since the decoupling of monetary policies became obvious, eurozone investors increased their holdings of U.S. treasuries by $50 billion to almost $1,600 billion.

Chart 9


Political uncertainties

Even if the ruling coalition retains a comfortable majority after the European parliamentary elections, it's unlikely that the installation of a new European Commission will happen rapidly. What's more, the consequences of the European elections at a national level, with France's snap parliamentary elections top of mind, are a source of uncertainty, weighing on financing conditions and possibly undermining the recovery in investment.

The ECB can trigger its transmission protection instrument to prevent any unwarranted tightening of financing conditions, provided that the country that the public debt purchases assist is not subject to an excessive deficit procedure by the European Commission. With the European Commission having announced the reopening of this procedure against five of the 20 eurozone member states, this reduces the ECB's scope to activate its transmission protection instrument. Our ECB rate forecasts are therefore more uncertain than usual and developments in financial conditions could affect them.

Europe's economic relationship with China

China's tit-for-tat response to the European Commission's decision to impose provisional countervailing duties on Chinese battery electric vehicle producers could undermine the close relationship between the two blocs. In terms of trade, China is Europe's second most important partner after the U.S. It accounts for 10% of total EU exports and 22% of EU imports, around half of which are products that are critical to the European economy.

Even though Chinese foreign direct investment in Europe (mostly through mergers and acquisitions) has fallen significantly over the past five years, China still holds significant equity stakes in some strategically important European companies. In parallel, EU foreign direct investment in China has remained steady at around €7 billion-€8 billion annually according to the European Commission, mostly concentrated in the automotive sector.

In terms of technology, the two blocs have become highly interdependent. China uses many European components, for example in electronics, automobiles, transport equipment, machine tools, chemicals, and pharmaceuticals, while Europe uses Chinese rare earth elements, batteries, and solar panels, among other critical products. China accounts for a double-digit share of foreign demand for many European industries and absorbs their domestic value added (see chart 10).

Chart 10


S&P Global Ratings' European economic forecasts (June 2024)
(%) Eurozone Germany France Italy Spain Netherlands Belgium Switzerland U.K.
2022 3.4 1.9 2.6 4.1 5.8 4.4 3.0 2.7 4.3
2023 0.6 0.0 1.1 1.0 2.5 0.2 1.4 0.7 0.1
2024 0.7 0.3 0.9 0.9 2.2 0.5 1.4 1.2 0.6
2025 1.4 1.2 1.4 1.2 1.9 1.5 1.4 1.5 1.2
2026 1.4 1.2 1.4 1.1 2.0 1.4 1.4 1.4 1.7
2027 1.3 1.1 1.3 1.0 2.0 1.5 1.3 1.5 1.7
CPI inflation
2022 8.4 8.7 5.9 8.7 8.3 11.6 10.3 2.8 9.1
2023 5.4 6.0 5.7 5.9 3.4 4.1 2.3 2.1 7.3
2024 2.4 2.7 2.6 1.4 3.0 2.8 3.9 1.4 2.8
2025 2.2 2.3 2.0 1.9 2.0 2.5 2.3 1.3 2.4
2026 1.9 1.9 1.8 1.7 2.0 1.9 2.0 1.1 2.1
2027 1.8 1.9 1.8 1.7 1.8 2.0 1.9 1.1 2.0
Unemployment rate
2022 6.7 3.1 7.3 8.1 13.0 3.5 5.6 4.4 3.9
2023 6.5 3.0 7.3 7.7 12.2 3.6 5.5 4.1 4.0
2024 6.5 3.3 7.6 7.3 11.6 3.8 5.6 4.2 4.4
2025 6.5 3.2 7.7 7.4 11.4 4.0 5.5 4.3 4.6
2026 6.4 3.1 7.5 7.4 11.3 3.9 5.5 4.1 4.4
2027 6.3 3.1 7.4 7.4 11.2 3.8 5.4 4.0 4.4
10-year government bond (yearly average)
2022 2.0 1.2 1.5 3.2 2.2 1.4 1.7 0.8 2.3
2023 3.3 2.5 2.9 4.3 3.5 2.8 3.1 1.1 3.9
2024 3.1 2.4 3.0 3.9 3.3 2.7 3.0 0.8 4.0
2025 3.1 2.4 2.9 4.0 3.2 2.7 2.9 1.2 3.6
2026 3.1 2.4 2.9 4.0 3.3 2.8 3.0 1.2 3.5
2027 3.2 2.5 3.0 4.1 3.4 2.8 3.1 1.2 3.5
Eurozone U.K. Switzerland
Exchange rates USD per EUR USD per GBP EUR per GBP CHF per USD CHF per EUR
2022 1.05 1.23 1.17 0.95 1.00
2023 1.08 1.24 1.15 0.90 0.97
2024 1.08 1.27 1.16 0.89 0.96
2025 1.09 1.29 1.14 0.90 0.98
2026 1.16 1.30 1.11 0.91 1.05
2027 1.17 1.30 1.11 0.91 1.07
Eurozone (ECB) U.K. Switzerland (SNB)
Policy rates (end of year) Deposit rate Refi rate Bank rate
2022 2.00 2.50 3.25 1.00
2023 4.00 4.50 5.25 1.75
2024 3.25 3.40 4.50 1.00
2025 2.50 2.65 3.25 1.00
2026 2.50 2.65 3.00 1.00
2027 2.50 2.65 3.00 1.00
CHF--Swiss franc. CPI--Consumer price index. ECB--European Central Bank. SNB--Swiss National Bank.

External Research

  • Dwindling investments become more concentrated – Chinese FDI in Europe: 2023 update, published by Rhodium Group and MERICS on June 6, 2024
  • Power and Financial Interdependence, published by the Council on Foreign Relations on May 15, 2024
  • Ain't No Duty High Enough, published by Rhodium Group on April 29, 2024
  • Regional Economic Outlook: Europe: Soft Landing in Crosswinds for a Lasting Recovery, published by the International Monetary Fund in April 2024
  • Understanding EU-China economic exposure, Economics Brief no. 4, published by the European Commission on Jan. 17, 2024

This report does not constitute a rating action.

EMEA Chief Economist:Sylvain Broyer, Frankfurt + 49 693 399 9156;
Economists:Aude Guez, Frankfurt 6933999163;
Sarah Limbach, Paris + 33 14 420 6708;

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