German Chancellor Olaf Scholz greets French President Emmanuel Macron before a private dinner at the “Kochzimmer” restaurant in Potsdam near Berlin, Germany, June 6, 2023.
Michael Kappeler | Swimming pool | via Reuters
Last year was upside down for the eurozone with its largest economies, Germany and France, in political and economic turmoil, meaning neither has a 2025 budget in place.
Economists say the trajectory of both countries is worrying and warn that lack of growth, fiscal imbalance and political intransigence could lead to the decline and loss of position of Europe as a whole.
“Today's situation is different from the earlier crisis (sovereign debt) in that Europe's most serious problems are no longer concentrated in smaller economies such as Greece. Instead, Europe's two most important economies are struggling,” Neil Shearing, group chief economist at Capital Economics, said in a December analysis.
“Europe faces continued decline without fundamental reforms at its core,” Shearing said, noting that unless this is done, “it is difficult to avoid the conclusion that Europe's future is one of very low economic growth, persistent concerns about the sustainability of public finances and a weakening sense of position in a world increasingly characterized by superpower rivalry between the US and China.”
In the current situation, neither France nor Germany has an adopted budget for 2025 in the face of political conflicts they ultimately overthrew their governments.
New elections will be held in Germany in February, and analysts are betting that new parliamentary elections will be held in France next summer. With the 2024 tax and spending rules postponed to this year, both countries are currently using interim budgets and it is unclear when either will agree on a 2025 budget.
France and Germany face different economic challenges, reflecting both the dangers of overspending and underspending.
According to the IMF, France recorded a budget deficit estimated at 6.1% and a debt in 2024 of 112%. The new government, led by Prime Minister Francois Bayrou, is expected to have difficulty persuading bickering MPs on all sides to adopt the 2025 budget. just like his predecessor Michel Barnier.
Meanwhile, Germany faces early federal elections in February after the collapse of the ruling coalition led by Chancellor Olaf Scholz in the fall due to divisions regarding economic and budgetary policy. Germany's problem is underpayment and underinvestment, which has led to weakening economic growth.
“In stark contrast, Germany's problem is overly stringent fiscal policy,” noted Shearing of Capital Economics.
“The so-called The “debt brake” significantly limits the scope for deficit spending, even though Germany's public debt burden is low. With the economy stagnating, Germany would benefit from a looser fiscal policy – and since this would almost certainly suck in imports from other countries, it would help support economic growth (and therefore fiscal consolidation) in France and Italy,” he noted.
We need to focus on growth
Economists say the lack of budget plans means Europe's largest economies will not be able to fully focus on policies aimed at economic expansion, continuing a worrying trend of anemic growth in recent years.
This was due to a confluence of events such as the war in Ukraine and rising energy prices, a factor that hit energy-intensive industries in Europe but was also exacerbated by weaker demand – both in terms of external demand from the likes of China and weaker consumer demand in Europe, and also deeper structural problems such as low productivity growth and lack of competitiveness.
The European Central Bank aims to stimulate economic activity in the euro area by cutting interest rates, introducing a cut of 25 basis points in December — the fourth cut this year — to raise the base interest rate to 3%. The central bank said it expects the euro area economy to grow at 0.7% in 2024 and 1.1% in 2025. Inflation in the EU was 2.4% in 2024 and 2.1% in this year.
Risks to economic growth “remain tilted towards decline,” ECB President Christine Lagarde said at a press conference in December, warning of the possibility of “greater frictions in global trade” and that “lower levels of confidence may prevent consumption and investment from recovering as quickly as expected. “
Some analysts, such as Kallum Pickering, chief economist at Peel Hunt, told CNBC that the ECB should show courage and decide on larger rate cuts in 2025.
Others argue that interest rate cuts cannot help solve structural problems such as low productivity growthand headwinds such as potential tariffs on imports from Europe destined for the USA to the USA., which will most likely be introduced by US President-elect Donald Trump.
“Our basic assumption is that 2025 will be quite a difficult year for Europe,” Jari Stehn, chief European economist at Goldman Sachs, told CNBC, with the investment bank forecasting euro zone economic growth of 0.8% in 2025. – compared to 2.5% in the US during the same period.
“There are a lot of problems… high energy prices, the slowdown in China, political uncertainty, trade tensions – these are all negative factors,” he told CNBC's “Squawk Box Europe.” However, investors continued to look for potential bright spots in the region.
“People are asking whether we could get more fiscal support in Germany when the new elections are held – maybe, we think there will be, but we think it will ultimately be limited,” Stehn said.
“People are also asking whether the European consumer may finally have a positive surprise, the savings rate is high, there is actually quite a lot of money (that can be spent), but again we think there will be some support, but it is unlikely that it will be a big surprise.”
Stehn noted that lower interest rates “will help to some extent with saving and consumer spending, and that's one of the reasons why we actually think Europe will grow next year, despite these challenges.”
“But at the same time, I think we also have to be realistic that many of the obstacles that we talked about (such as energy prices, China, structural issues. Rate cuts are not going to solve all of these problems,” he said.
“Ultimately, it will be a challenging environment.”