European Central Bank — Economic Bulletin (Europe, 2025)

Economic Bulletin Issue 4 / 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 US financial conditions and their link to economic activity: the role of equity valuations US trade policies and the activity of US multinational enterprises in the euro area The outlook for euro area business investment   findings from an ECB survey of large firms Where do we stand with inflationary pressures arising from price resetting? Financial market volatility and economic policy uncertainty: bridging the gap Determinants of inflation expectations of firms in the SAFE Liquidity conditions and monetary policy operations from 5 February to 22 April 2025 Articles 1 The transmission of monetary policy: from mortgage rates to consumption Box 1 The state dependence of monetary policy: differences in pass- through across easing cycles Box 2 The role of anticipation assumptions for the timing of consumption effects 3 3 8 14 21 28 34 40 44 44 49 55 61 68 73 79 85 85 91 95 Economic Bulletin, Issue 4 / 2025   Contents 1 2 Advancing the capital markets union in Europe: a roadmap for harmonising securities post-trading Box 1 Post-trading activities: areas for harmonisation under the single European rulebook Statistics 100 109 S1 Economic Bulletin, Issue 4 / 2025   Contents 2 Economic, financial and monetary developments Overview At its meeting on 5 June 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   was based on its updated assessment of the inflation outlook, the dynamics of underlying inflation and the strength of monetary policy transmission. Inflation is currently at around the Governing Council s 2% medium-term target. In the baseline of the June 2025 Eurosystem staff macroeconomic projections for the euro area, headline inflation is set to average 2.0% in 2025, 1.6% in 2026 and 2.0% in 2027. The downward revisions compared with the March 2025 ECB staff macroeconomic projections for the euro area, by 0.3 percentage points for both 2025 and 2026, mainly reflect lower assumptions for energy prices and a stronger euro. Staff expect inflation excluding energy and food to average 2.4% in 2025 and 1.9% in 2026 and 2027, broadly unchanged since March. Staff see real GDP growth averaging 0.9% in 2025, 1.1% in 2026 and 1.3% in 2027. The unrevised growth projection for 2025 reflects a stronger than expected first quarter combined with weaker prospects for the remainder of the year. While the uncertainty surrounding trade policies is expected to weigh on business investment and exports, especially in the short term, rising government investment in defence and infrastructure will increasingly support growth over the medium term. Higher real incomes and a robust labour market will allow households to spend more. Together with more favourable financing conditions, this should make the economy more resilient to global shocks. In the context of high uncertainty, staff also assessed some of the mechanisms by which different trade policies could affect growth and inflation under some alternative illustrative scenarios. These scenarios are published with the staff projections on the ECB s website. Under this scenario analysis, a further escalation of trade tensions over the coming months would result in growth and inflation being below the baseline projections. By contrast, if trade tensions were resolved with a benign outcome, growth and, to a lesser extent, inflation would be higher than in the baseline projections. Most measures of underlying inflation suggest that inflation will settle at around the Governing Council s 2% medium-term target on a sustained basis. Wage growth is still elevated but continues to moderate visibly, and profits are partially buffering its impact on inflation. The concerns that increased uncertainty and a volatile market response to the trade tensions in April would have a tightening impact on financing conditions have eased. Economic Bulletin, Issue 4 / 2025   Economic, financial and monetary developments Overview 3 The Governing Council is determined to ensure that inflation stabilises sustainably at its 2% medium-term target. Especially in current conditions of exceptional uncertainty, it will follow a data-dependent and meeting-by-meeting approach to determining the appropriate monetary policy stance. 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. Economic activity The economy grew by 0.3% in the first quarter of 2025, according to Eurostat s flash estimate. Unemployment, at 6.2% in April, is at its lowest level since the launch of the euro, and employment grew by 0.3% in the first quarter of the year, according to the flash estimate. The outlook for euro area economic growth is clouded by trade tensions and elevated global uncertainty. For 2025 as a whole, these effects are seen to be partly compensated by stronger than expected economic activity in the first quarter, which likely reflects in part the frontloading of exports in anticipation of higher tariffs. In the medium term economic activity is seen to be supported by the recently announced new fiscal measures. The June 2025 baseline projections assume that US tariffs on EU goods, which have increased to 10%, will remain in place over the entire projection horizon. Together with the elevated trade policy uncertainty and the recent appreciation of the euro, the higher tariffs will weigh on euro area exports and investment, and, to a lesser extent, on consumption. By contrast, new government spending on infrastructure and defence, mainly in Germany, should bolster euro area domestic demand from 2026 onwards. Overall, the conditions remain in place for euro area GDP growth to strengthen over the projection horizon. In particular, rising real wages and employment, less restrictive financing conditions   mainly reflecting recent monetary policy decisions   and a rebound in foreign demand in the later part of the projection horizon should all support a gradual recovery. Compared with the March 2025 projections, the outlook for GDP growth is unrevised for 2025, reflecting better than expected incoming data which are seen to be largely offset by the effects of the trade tensions and the appreciation of the euro exchange rate. The trade tensions and the stronger exchange rate have resulted in a downward revision to growth for 2026, while growth is unrevised for 2027. In line with the June 2025 projections, survey data point overall to some weaker prospects in the near term. While manufacturing has strengthened, partly because trade has been brought forward in anticipation of higher tariffs, the more domestically oriented services sector is slowing. Higher tariffs and a stronger euro are expected to make it harder for firms to export. High uncertainty is expected to weigh on investment. At the same time, several factors are keeping the economy resilient and should support growth over the medium term. A strong labour market, rising real incomes, Economic Bulletin, Issue 4 / 2025   Economic, financial and monetary developments Overview 4 robust private sector balance sheets and easier financing conditions, in part because of the Governing Council s past interest rate cuts, should all help consumers and firms withstand the fallout from a volatile global environment. Recently announced measures to step up defence and infrastructure investment should also bolster growth. In the present geopolitical environment, it is even more urgent for fiscal and structural policies to make the euro area economy more productive, competitive and resilient. The European Commission s Competitiveness Compass provides a concrete roadmap for action, and its proposals, including on simplification, should be swiftly adopted. This includes completing the savings and investment union, following a clear and ambitious timetable. It is also important to rapidly establish the legislative framework to prepare the ground for the potential introduction of a digital euro. Governments should ensure sustainable public finances in line with the EU s economic governance framework, while prioritising essential growth-enhancing structural reforms and strategic investment. Inflation Annual inflation declined to 1.9% in May, from 2.2% in April, according to Eurostat s flash estimate. Energy price inflation remained at -3.6%. Food price inflation rose to 3.3%, from 3.0% the month before. Goods inflation was unchanged at 0.6%, while services inflation dropped to 3.2%, from 4.0% in April. Services inflation had jumped in April mainly because prices for travel services around the Easter holidays went up by more than expected. Most indicators of underlying inflation suggest that inflation will stabilise sustainably at the Governing Council s 2% medium-term target. Labour costs are gradually moderating, as indicated by incoming data on negotiated wages and available country data on compensation per employee. The ECB s wage tracker points to a further easing of negotiated wage growth in 2025, while the June 2025 projections see wage growth falling to below 3% in 2026 and 2027. While lower energy prices