European Central Bank — Economic Bulletin (Europe, 2025)

Economic Bulletin Issue 1 / 2025 Contents Economic, financial and monetary developments Summary External environment Economic activity Prices and costs Financial market developments Financing conditions and credit developments 1 2 3 4 5 Boxes 1 2 3 4 5 6 7 8 The outlook for services inflation in the United States and the United Kingdom Are real incomes increasing or not? Household perceptions and their role for consumption The role of demographics in recent developments in the unemployment rate The economic impact of floods Main findings from the ECB s recent contacts with non-financial companies Changes to the Eurosystem collateral framework to foster greater harmonisation From press conferences to speeches: the impact of the ECB s monetary policy communication Natural rate estimates for the euro area: insights, uncertainties and shortcomings Articles 1 European competitiveness: the role of institutions and the case for structural reforms Box 1 Physical and digital infrastructures in Europe 2 Wage developments during and after the high inflation period 3 3 7 12 20 26 30 38 38 44 49 54 59 64 68 73 79 79 92 95 Box 1 Time variation in the slope of the wage Phillips curve 107 ECB Economic Bulletin, Issue 1 / 2025   Contents 1 Box 2 Wages and the pass-through of shocks to inflation 3 Green investment needs in the EU and their funding Statistics 113 116 S1 ECB Economic Bulletin, Issue 1 / 2025   Contents 2 Economic, financial and monetary developments Summary At its meeting on 30 January 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 in line with the December 2024 Eurosystem staff macroeconomic projections for the euro area and is set to return to the Governing Council s 2% medium-term target in the course of 2025. Most measures of underlying inflation suggest that inflation will settle at around the 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. The Governing Council s recent interest rate cuts are gradually making new borrowing less expensive for firms and households. At the same time, financing conditions continue to be tight, also because monetary policy remains restrictive and past interest rate hikes are still transmitting to the stock of credit, with some maturing loans being rolled over at higher rates. The economy is still facing headwinds but rising real incomes and the gradually fading effects of restrictive monetary policy should support a pick-up in demand over time. The Governing Council is determined to ensure that inflation stabilises sustainably at its 2% medium-term target. 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. Economic activity The economy stagnated in the fourth quarter of 2024, according to Eurostat s preliminary flash estimate. It is set to remain weak in the near term. Surveys indicate that manufacturing continues to contract while services activity is expanding. Consumer confidence is fragile, and households have not yet drawn sufficient encouragement from rising real incomes to significantly increase their spending. ECB Economic Bulletin, Issue 1 / 2025   Economic, financial and monetary developments Summary 3 Nevertheless, the conditions for a recovery remain in place. While the labour market has softened over recent months it continues to be robust, with the unemployment rate staying low, at 6.3% in December. A solid job market and higher incomes should strengthen consumer confidence and allow spending to rise. More affordable credit should also boost consumption and investment over time. Provided trade tensions do not escalate, exports should support the recovery as global demand rises. Fiscal and structural policies should make the economy more productive, competitive and resilient. The Governing Council welcomes the European Commission s Competitiveness Compass, which provides a concrete roadmap for action. It is crucial to follow up, with further concrete and ambitious structural policies, on Mario Draghi s proposals for enhancing European competitiveness and on Enrico Letta s proposals for empowering the Single Market. Governments should implement their commitments under the EU s economic governance framework fully and without delay. This will help bring down budget deficits and debt ratios on a sustained basis, while prioritising growth-enhancing reforms and investment. Inflation Annual inflation increased to 2.4% in December 2024, up from 2.2% in November. As in the previous two months, the increase was expected and primarily reflected past sharp drops in energy prices falling out of the calculation. Along with a month- on-month increase in December, this pushed up energy prices slightly on an annual basis, after four consecutive declines. Food price inflation edged down to 2.6% and goods inflation to 0.5%. Services inflation edged up to 4.0%. Most underlying inflation indicators have been developing in line with a sustained return of inflation to the Governing Council s medium-term target. Domestic inflation, which closely tracks services inflation, has remained high, as wages and some services prices are still adjusting to the past inflation surge with a substantial delay. At the same time, recent signals point to continued moderation in wage pressures and to the buffering role of profits. The Governing Council expects inflation to fluctuate around its current level in the near term. It should then settle sustainably at around the 2% medium-term target. Easing labour cost pressures and the continuing impact of the Governing Council s past monetary policy tightening on consumer prices should help this process. While market-based indicators of inflation compensation have largely reversed the declines observed in autumn 2024, most measures of longer-term inflation expectations continue to stand at around 2%. Risk assessment The risks to economic growth remain tilted to the downside. Greater friction in global trade could weigh on euro area growth by dampening exports and weakening the global economy. Lower confidence could prevent consumption and investment from ECB Economic Bulletin, Issue 1 / 2025   Economic, financial and monetary developments Summary 4 recovering as fast as expected. This could be amplified by geopolitical risks, such as Russia s unjustified war against Ukraine and the tragic conflict in the Middle East, which could disrupt energy supplies and further weigh on global trade. Growth could also be lower if the lagged effects of monetary policy tightening last longer than expected. It could be higher if easier financing conditions and falling inflation allow domestic consumption and investment to rebound faster. Inflation could turn out higher if wages or profits increase by more than expected. Upside risks to inflation also stem from the heightened geopolitical tensions, which could push energy prices and freight costs higher in the near term and disrupt global trade. Moreover, extreme weather events, and the unfolding climate crisis more broadly, could drive up food prices by more than expected. By contrast, inflation may surprise on the downside if low confidence and concerns about geopolitical events prevent consumption and investment from recovering as fast as expected, if monetary policy dampens demand by more than expected, or if the economic environment in the rest of the world worsens unexpectedly. Greater friction in global trade would make the euro area inflation outlook more uncertain. Financial and monetary conditions Market interest rates in the euro area have risen since the Governing Council s meeting on 12 December 2024, partly mirroring higher rates in global financial markets. While financing conditions remain tight, the Governing Council s interest rate cuts are gradually making it less expensive for firms and households to borrow. The average interest rate on new loans to firms declined to 4.5% in November, while the cost of issuing market-based debt remained at 3.6%. The average rate on new mortgages edged down to 3.5%. Growth in bank lending to firms rose to 1.5% in December, up from 1.0% in November, amid a strong monthly flow. Growth in debt securities issued by firms moderated to 3.2% in annual terms. Mortgage lending continued to rise gradually but remained muted overall, with an annual growth rate of 1.1%. Credit standards for business loans tightened again in the fourth quarter of 2024, having broadly stabilised over the previous four quarters, as reported in the January 2025 bank lending survey. The renewed tightening mainly reflected banks becoming more concerned about the risks faced by their customers and less willing to take on risks themselves. Demand for loans