European Central Bank — Economic Bulletin (Europe, 2025)

Economic Bulletin Issue 2 / 2025 Contents Economic, financial and monetary developments Overview External environment Economic activity Prices and costs Financial market developments Financing conditions and credit developments Fiscal developments 1 2 3 4 5 6 Boxes 1 2 3 4 5 6 7 8 Business investment: why is the euro area lagging behind the United States? Have euro area exports missed the tech train? The increasing energy demand of artificial intelligence and its impact on commodity prices Using corporate earnings calls to forecast euro area labour demand Euro area rent developments: insights from the CES Understanding the relative development of goods and services inflation Insights from banks and firms on euro area credit conditions: a comparison based on ECB surveys Liquidity conditions and monetary policy operations from 23 October 2024 to 4 February 2025 Article 1 Developments in the recent euro area house price cycle Box 1 The fundamental drivers of euro area house prices Box 2 The relation between rental and house prices: how indicative is this for the euro area? Statistics ECB Economic Bulletin, Issue 2 / 2025   Contents 2 2 7 13 20 27 33 39 43 43 49 55 58 62 68 72 77 83 83 95 97 S1 1 Economic, financial and monetary developments Overview At its meeting on 6 March 2025, the Governing Council decided to lower the three key ECB interest rates by 25 basis points. In particular, the decision to lower the deposit facility rate   the rate through which the Governing Council steers the monetary policy stance   is based on its updated assessment of the inflation outlook, the dynamics of underlying inflation and the strength of monetary policy transmission. The disinflation process is well on track. Inflation has continued to develop broadly as staff expected, and the March 2025 ECB staff macroeconomic projections for the euro area closely align with the previous inflation outlook. Staff now see headline inflation averaging 2.3% in 2025, 1.9% in 2026 and 2.0% in 2027. The upward revision in headline inflation for 2025 reflects stronger energy price dynamics. For inflation excluding energy and food, staff project an average of 2.2% in 2025, 2.0% in 2026 and 1.9% in 2027. Most measures of underlying inflation suggest that inflation will settle at around the Governing Council s 2% medium-term target on a sustained basis. Domestic inflation remains high, mostly because wages and prices in certain sectors are still adjusting to the past inflation surge with a substantial delay. But wage growth is moderating as expected, and profits are partially buffering the impact on inflation. Monetary policy is becoming meaningfully less restrictive, as the interest rate cuts are making new borrowing less expensive for firms and households and loan growth is picking up. At the same time, a headwind to the easing of financing conditions comes from past interest rate hikes still transmitting to the stock of credit, and lending remains subdued overall. The economy faces continued challenges and staff have again marked down their growth projections   to 0.9% for 2025, 1.2% for 2026 and 1.3% for 2027. The downward revisions for 2025 and 2026 reflect lower exports and ongoing weakness in investment, in part originating from high trade policy uncertainty as well as broader policy uncertainty. Rising real incomes and the gradually fading effects of past rate hikes remain the key drivers underpinning the expected pick-up in demand over time. The Governing Council is determined to ensure that inflation stabilises sustainably at its 2% medium-term target. Especially in current conditions of rising uncertainty, it will follow a data-dependent and meeting-by-meeting approach to determining the appropriate monetary policy stance. In particular, the Governing Council s interest rate decisions will be based on its assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation and the strength of monetary policy transmission. The Governing Council is not pre- committing to a particular rate path. ECB Economic Bulletin, Issue 2 / 2025   Economic, financial and monetary developments Overview 2 Economic activity The euro area economy likely grew modestly in the fourth quarter of 2024. The first two months of 2025 saw a continuation of many of the previous year s patterns. Manufacturing is still a drag on growth even if survey indicators are improving. High uncertainty, both at home and abroad, is holding back investment and competitiveness challenges are weighing on exports. At the same time, services are resilient. Moreover, rising household incomes and the robust labour market are supporting a gradual pick-up in consumption, although consumer confidence is still fragile and saving rates are high. The unemployment rate stayed at its historical low of 6.2% in January 2025, and employment is estimated to have grown by 0.1% in the last quarter of 2024. However, demand for labour has moderated, and recent survey data suggest that employment growth was subdued in the first two months of 2025. Persistently high geopolitical and policy uncertainty is expected to weigh on euro area economic growth, especially in investment and exports, slowing down the anticipated recovery. This follows slightly weaker than expected growth at the end of 2024. Both domestic and trade policy uncertainty are high. Although the baseline projection only includes the impact of new tariffs on trade between the United States and China, the negative effects of uncertainty regarding the possibility of further changes in global trade policies, particularly vis- -vis the European Union, are assumed to weigh on euro area exports and investment. This, coupled with persistent competitiveness challenges, is assessed to lead to a further decline in the euro area s export market share. Despite these headwinds, the conditions remain in place for euro area GDP growth to strengthen again over the projection horizon. Rising real wages and employment, in the context of a strong, albeit cooling, labour market, are expected to support a recovery in which consumption remains a key contributor to growth. Domestic demand should also be supported by an easing of financing conditions, as implied by market expectations about the future path of interest rates. The labour market should remain resilient, with the unemployment rate expected to average 6.3% in 2025, edging down to 6.2% in 2027. As some of the cyclical factors that have recently reduced productivity start to unwind, productivity is expected to pick up over the projection horizon, although structural challenges remain. Overall, annual average real GDP growth is expected to be 0.9% in 2025, and to strengthen to 1.2% in 2026 and to 1.3% in 2027. Compared with the December 2024 Eurosystem staff macroeconomic projections for the euro area, the outlook for GDP growth has been revised down by 0.2 percentage points for both 2025 and 2026, but is unchanged for 2027. The weaker outlook is mainly due to downward revisions to exports and, to a lesser extent, to investment, reflecting a stronger impact of uncertainty than previously assumed, as well as expectations that competitiveness challenges will likely persist for longer than had been anticipated. Fiscal and structural policies should make the economy more productive, competitive and resilient. The European Commission s Competitiveness Compass provides a concrete roadmap for action and its proposals should be swiftly adopted. Governments should ensure sustainable public finances in line with the EU s ECB Economic Bulletin, Issue 2 / 2025   Economic, financial and monetary developments Overview 3 economic governance framework and prioritise essential growth-enhancing structural reforms and strategic investment. Inflation According to Eurostat s flash estimate, annual inflation stood at 2.4% in February 2025, after 2.5% in January and 2.4% in December 2024. Energy price inflation slowed to 0.2%, following a strong increase to 1.9% in January, from 0.1% in December. By contrast, food price inflation rose to 2.7%, from 2.3% in January and 2.6% in December. Goods inflation ticked up to 0.6%, while services inflation eased to 3.7%, from 3.9% in January and 4.0% in December. Most indicators of underlying inflation are pointing to a sustained return of inflation to the Governing Council s 2% medium-term target. Domestic inflation, which closely tracks services inflation, declined in January 2025. But it remains high, as wages and some services prices are still adjusting to the past inflation surge with a substantial delay. At the same time, recent wage negotiations point to a continued moderation in labour cost pressures. Headline HICP inflation has increased over recent months but is projected to moderate marginally in the course of 2025 and then to decline and hover around the Governing Council s inflation target of 2% from the first quarter of 2026. At the start of the projection horizon upward base effects in the energy component and higher food price inflation are expected to broadly offset downward impacts from a decline in HICP inflation excluding energy and food (HICPX). The rise in energy commodity prices at the turn of the year will carry over into the annual rate of change in energy prices in 2025. Although oil and gas prices are assumed to decline in line with futures prices, energy inflation is likely to continue to record positive rates, albeit below the historical average, over the entire projection horizon. In 2027 energy inflation is seen to be driven up by the introduction of new climate change mitigation measures. Food inflation is projected