After five quarters of stagnation, the EU economy returned to modest growth in the first three quarters of the year, while the disinflation process continued. According to the European Commission Autumn Forecast, the conditions for a continued gradual pick-up in growth in 2025 and 2026 are in place. Financial conditions are easing; the labour market remains strong; the disinflationary process is seen as solidly in place; and households’ disposable incomes are set to continue expanding. Elevated uncertainty at home and abroad is estimated to have exerted a considerable drag on growth and is likely to continue doing so. Fostering a more predictable economic environment could further lift growth over the forecast horizon.
The forceful tightening of financial conditions contributed to five consecutive quarters of broad stagnation in the EU from late 2022 through 2023, but largely achieved its goal of a steady decline in inflation. Remarkably, the labour market has continued to show resilience — a soft landing under challenging circumstances. In 2024, the EU economy returned to growth. Despite recovering purchasing power, many households restrained their consumption and opted instead to save more due to lingering inflationary concerns and, to a lesser extent, higher interest rates (Baldassarri et al. 2024). Bobasu et al. (2024) also highlight the role of declining housing prices and uncertainty. By mid-year, the household saving rate had risen significantly to 14.8%, three percentage points above its pre-pandemic long-term average. At the same time, investment contracted sharply. Even net of one-off transactions in intellectual property, residential construction continued declining and equipment investment fell sharply, too. Beyond still tight financial conditions and falling profit margins, Revoltella et al. (2024) point to the role of elevated energy costs and uncertainty. With growth of imports lagging behind growth of exports, net trade turned out to be the main driver of growth.
Weakening contribution from net trade and fiscal consolidation will impact growth…
According to the Commission’s Autumn Forecast (European Commission 2024), merchandise and services exports will continue to expand. But import growth will also rise on the back of higher demand. Trade dynamics are thus projected to remain favourable but net trade will no longer prop up EU growth.
Fiscal consolidation is underway. The EU general government deficit is projected to have resumed its decline this year, supported by revenue windfalls and restrained spending, though high interest rates are weighing on public debt. Fiscal policy is estimated to exert a mildly contractionary impact on the EU economy, particularly in 2024 due to the phasing out of ‘energy measures’ that provided support to private investments, especially housing renovations in Italy. In 2025, the contractionary impact of national fiscal policies on economic activity is expected to be offset by the accelerated utilisation of EU funds, including the Recovery and Resilience Fund. The forecast for 2025 however does not include the draft budgetary plans for a few member states – Austria, Belgium, Croatia, Spain – which had not been submitted to the Commission by the cutoff date. For 2026, the fiscal projections in the Autumn Forecast do not include the still unspecified measures needed to achieve the adjustment path planned in member states’ medium-term fiscal-structural plans. The proper implementation of the plans is estimated to imply a slightly contractionary EU fiscal stance in 2026 which, also depending on the nature of the underpinning measures, can be expected to weigh on the GDP growth outlook.
…while credit conditions are set to ease markedly
With energy inflation cooling, overall inflation resumed its downward trend in August. Looking forward, the disinflation process hinges upon easing price pressures in services, as nominal wage growth slows down and productivity resumes growing.
All signs point to a solid disinflationary trend. The ECB has lowered interest rates three times since May, and further substantial loosening (125 basis points) is expected by the end of 2025. Financial conditions are also easing markedly, as retail rates are set to keep falling and credit standards to keep loosening.
Domestic demand is set to rebound, while service inflation keeps easing
Although the labour market has loosened somewhat, job creation continues, especially benefiting women, older workers, and foreign-born jobseekers. Employment growth is projected to slow down further, with job intensity of growth converging towards pre-pandemic rates. Wage growth, following a peak in 2023, is set to slow yet should continue to outpace inflation, restoring real purchasing power for households. Households, having accumulated savings and improved their financial positions, are expected to lower their saving rates slightly, leading to gradual acceleration in consumption growth.
Households, having accumulated savings and improved their financial positions, are expected to lower their saving rates slightly, leading to gradual acceleration in consumption growth.
Figure 1 Real gross disposable income and private consumption
Source: European Commission Autumn Forecast
Figure 2 Investment growth and its composition by asset type
Source: European Commission Autumn Forecast
A global recovery for manufacturing and trade of goods, coupled with easing conditions and improving profit margins, set the stage for a rebound in investment. Recovery and Resilience Facility (RRF) funding is also set to help businesses transition to energy-efficient, low-emission production, though ongoing structural changes could challenge segments of manufacturing, especially energy-intensive and automotive sectors. Residential construction remains subdued in 2025, but is expected to recover by 2026 – leading to a broad-based acceleration of investment.
The Autumn Forecast sees a gradual acceleration of economic activity, amidst further decelerating inflation
The forecast projects moderate real GDP growth of 0.9 % for the EU in 2024 and an acceleration to 1.5% and 1.8%, respectively, in 2025 and 2026. Inflation is expected to halve in 2024 and continue easing. However, elevated uncertainty, at home and abroad, is weighing on the EU economy.
Figure 3 GDP growth and its components
Source: European Commission Autumn Forecast
Figure 4 HICP inflation and components
Source: European Commission Autumn Forecast
Elevated uncertainty is estimated to exert a heavy toll on economic activity, especially investment
Uncertainty – proxied by the Economic Policy Uncertainty (EPU) index by Baker et al. (2016) – has been on the rise, particularly over the last few quarters. Elevated uncertainty reflects heightened geopolitical tensions, especially in the EU’s eastern and south-eastern neighbourhood, but also domestic political instability, especially in France and Germany.
To quantify the effects of uncertainty on the economy, a vector autoregressive (VAR) model 2 was used to gauge how sudden increases in uncertainty influence investment and GDP within the euro area. Results suggest that each unexpected surge in uncertainty, equivalent to a one standard deviation shock, exerts a cumulative drag of approximately 0.45 percentage points on GDP growth within a year. Investment is particularly sensitive to these conditions: faced with a murky economic outlook, companies often defer or cancel spending, particularly on capital projects, until greater clarity emerges.Consumption, though less impacted than investment, is not immune as households tend to increase precautionary savings.
Figure 5 Economic policy uncertainty in the euro area and alternative scenarios over the forecast period
Notes: (*) GDP-weighted average across EPU indices of Germany, France, Italy and Spain, which is used to approximate uncertainty in the euro area. (**) Alternative scenarios include the return to the average level of the pre-Great Financial Crisis period (2001Q1-2008Q4, PRE-GFC), the pre-COVID period (2009Q1-2019Q4, pre-COVID), the post-COVID period (2020Q1-2024Q2) as well as a level 50% higher than the average level of the post-COVID periods.
Source: https://www.policyuncertainty.com
A progressive decline of uncertainty would significantly boost GDP growth over the forecast horizon
Looking forward, a scenario analysis further underscores the economic stakes associated with different uncertainty paths. If uncertainty in the euro area were to return to pre-pandemic levels by the end of the forecast period, it could boost GDP by up to 1.2 percentage points, given the positive effects this would have on restoring confidence in both private consumption and business investment. Under a more optimistic scenario, where uncertainty reverts to levels seen before the Global Financial Crisis, the boost to GDP could reach as high as 1.7 points. However, if uncertainty were to rise by another 50% above current post-pandemic levels, the implications would be adverse, resulting in an estimated 0.6% reduction in GDP, further depressing both consumption and investment growth across the region.
Note: The estimated impacts are based on forecasting from a VARX model estimated for the euro area, conditional on the scenario trajectories for uncertainty represented in Figure 5.
While the impact of an individual uncertainty shock eventually dies out, repeated exposure to episodes of high uncertainty can leave lasting scars by making businesses and households more risk-averse. This ‘hysteresis effect’ leads firms and individuals to adopt a more cautious outlook even once stability returns.
EU policymakers must strive to foster a more predictable economic environment. Much of the uncertainty affecting the EU originates beyond its borders. Stability in domestic policy, even amid global turbulence, would go a long way towards ensuring that businesses and households feel secure enough to invest and spend, bolstering economic growth in the process. Creating clear and stable policy signals will be crucial to support investment and consumption.
Source : VOXeu
