WanSquare - The year 2025 seen by... Michala Marcussen

Translation of an article published by WanSquare on 27 December 2024
By Michala MARCUSSEN, Group Chief Economist

What is your growth scenario for Europe and France in 2025? How are the geopolitical risks (Ukraine, Middle East, new Trump administration, German federal elections) likely to affect your forecasts?

2025 is set to mark yet a year of subdued growth for the euro area at below 1%, with the region facing headwinds on both the domestic and international front. High uncertainty, already an issue in 2024, is set to remain throughout much of 2025, holding back business investment and keeping precautionary consumer savings high. This uncertainty stems both from domestic political situations, not least in France and Germany, and external factors, with ongoing conflicts and the threat of tariffs from the incoming Trump administration. On a positive note, energy prices today remain in check, but this is clearly one of the key channels through which geopolitical conflicts could spillover and merits close attention heading into 2025.

Fiscal policy tightening is also on the cards across several of the euro area’s large member states, weighing on growth in the short-term, but delivering longer term benefits in the form of sustainable public finances. Export demand is furthermore set to remain lacklustre. On a more positive note, ongoing disinflation and ECB rate cuts should offer some support. High savings, moreover, offer an opportunity for demand, but unlocking this will require a significant boost to both corporate and household confidence.

Should we expect a marked divergence between the monetary policies of the European Central Bank and the US Federal Reserve?

The US economy is set to see 2024 real GDP growth clock in at more than twice the pace of the euro area, at around 2.5%. Looking ahead to 2025, tax cuts and deregulation should initially further sustain favourable US growth dynamics. Ironically, the fast pace of immigration that has in recent years helped keep wage-price spirals in check and lifted private consumption, could soon end abruptly. Combined with higher tariffs, this would add to inflationary pressures and narrow the room for Fed rate cuts. It is worth recalling that the starting point for the second Trump Administration is very different from the one that prevailed back in 2017. Back then, the Fed funds rate stood at just 0.75% and the US had seen a long period of low inflation. Today, the Fed funds rate stands at 4.75% with inflation still running above target, albeit well down from the peak of 9.1% observed in 2022. The federal debt level is also much higher as well as international US tariffs. As such, upside risks to US inflation are today much higher and it is no surprise that market expectations for Fed rate cuts have been significantly trimmed back with the elections. The risk that any near-term US boom ends in a bust is much higher today than in 2017.

The Fed is only too well aware of these risks and 2025 thus promises to see more rate cuts from the ECB than from the Fed. It is worth recalling that both the Fed and the ECB will also be making decisions on their bond purchase programmes. The Fed is expected to end its policy of quantitative tightening in early 2025, offering some support to long US bond yields. The ECB, on the other hand, promises further reduction of its balance sheet in 2025, which all else being equal, will add to tighter monetary conditions. The ECB could thus consider reversing quantitative tightening, offering support to the real economy also through this channel.

2024 was the year of the Draghi, Noyer and Letta reports, and of the realisation that Europe was falling behind. What urgent measures need to be taken at European level to turn the tide and free the old continent from the US-China pincers?

2024 saw the release of several key reports identifying the root causes of Europe’s lack of competitiveness, and setting out solutions on how these issues can be addressed. Once again, we observe that there is no shortage of ideas on how to unlock Europe’s growth potential, to secure investment and jobs, and the sustainability of the region’s social models. The hurdle in delivering on these ideas often boils down to the question of risk sharing. In delivering the Next Generation EU funds during the pandemic, Europe demonstrated a strong capacity for risk sharing and driving investments that benefit all. Waiting until the next crisis to make a quantum leap on addressing European competitiveness would come at a high cost, not least in an ever more fragmented international context.

Risk sharing is not the only hurdle, however. As outlined by French Governor Villeroy de Galhau in his speech on 26 November, there are significant potential wins from more efficient regulation and from making sure that Europe enjoys a level playing field internationally.

The Chinese economy has been in trouble for several quarters due to a real estate crisis. Do you think that the recent introduction of a new set of fiscal, monetary, and regulatory measures is likely to bring it down?

China continues to manage a delicate balancing act in unwinding the past excesses in real estate, while at the same time shifting to new and more sustainable growth engines. Having already gained a significant share of global export markets and now also facing further risks of tariffs, those sustainable growth engines must be found on the domestic front, unlocking private consumption and private investment.

Many of the policy measures in 2024 focused on ensuring orderly deleveraging of the real estate sector but looking ahead to 2025 we expect to see more focus on private consumption and the latest announcements from the Central Economic Work Conference seem to confirm this expectation. Strengthening social safety nets is one way to unlock consumer confidence and reduce high precautionary saving levels but this will take time and social welfare is clearly seen as also carrying risks of “laziness”. Further boosting incentives to spend on durable goods and thus absorb excess domestic production capacity is also on the cards.

While these measures will be supportive, we see a need for further structural reform to free up private entrepreneurship and expect to see growth in 2025 again fall short of 5%.

What is the biggest threat to global financial stability that could materialise in 2025?

Global equity markets touched new highs in the final weeks of 2024, with the risk that major setbacks for the real economy, be it triggered by geopolitical events or policy errors, could bring about substantial adjustments of market valuations. While such tremors could make for spectacular headlines, the well capitalised positions of global banks make a replay the 2008 crisis highly unlikely.

The greater concern is that 2025 may sow seeds for future financial crises, not least if the push for deregulation in the US sees poor investor protection and poor risk management result, not least in the non-banking sector. Closely related hereto is also the risk of fragmentation, be it in terms of global financial regulation or global financial flows.

For Europe, the risk is a lack of progress on Capital Markets Union. While this does not present any immediate risk to financial stability, the absence of a Capital Markets Union is one of the key reasons behind Europe’s low growth trap and ultimately a prolonged period of weak growth can become a risk to financial stability, not least with the resulting risks to sovereign debt sustainability and political stability.

Not only did France fail to anticipate the significant deterioration in its public finances in 2023 and 2024, but it could also find itself in a politically unstable situation in the long term. Should it fear a crisis of confidence on the bond markets in the near future?

France has for many years enjoyed a very stable political environment and this has brought significant benefits in keeping the interest rate spread over Germany at moderate levels, in turn supporting the real economy. The political fragmentation brought about by the result of last summer’s elections has already come at an important cost, with long French bond yields trading though Spain and now trading close to Greece. This higher spread holds back both investment and jobs. Looking ahead to 2025, key now is to secure a credible budget steering France to a path of sustainable public finances. Failure to do so would see France suffer rating downgrades and further spread widening, weighing on growth and ultimately forcing dire austerity. When it comes to public finances, a stich in time really does save nine.