European Central Bank — Economic Bulletin (Europe, 2025)

Economic Bulletin Issue 5 / 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 Consumer confidence and household consumption decisions What does increasing competition from China mean for euro area employment? Main findings from the ECB s recent contacts with non-financial companies Real wage catch-up in the euro area Uncertainty in seasonally adjusted services inflation: the role of Easter and travel Higher defence spending and its impact on household expectations Fiscal aspects of European defence spending: implications for euro area macroeconomic projections and associated risks Articles 1 Unveiling the hidden costs of critical dependencies Box 1 Addressing critical dependencies: the EU approach Box 2 A data-driven methodology for identifying critical dependencies Box 3 A complementary network analysis 2 Activity and price discovery in euro area inflation-linked swap markets Box 1 The responsiveness of counterparties in the euro area inflation-linked swap market Economic Bulletin Issue 5 / 2025   Contents 3 3 7 11 18 25 28 37 37 44 49 53 59 64 71 77 77 78 83 89 100 108 1 3 Cash is alive  and somewhat young? Decoupling age, period and cohort from euro cash use Statistics 113 S1 Economic Bulletin Issue 5 / 2025   Contents 2 Economic, financial and monetary developments Summary At its meeting on 24 July 2025, the Governing Council decided to keep the three key ECB interest rates unchanged. Inflation is currently at the 2% medium-term target. The incoming information is broadly in line with the Governing Council s previous assessment of the inflation outlook. Domestic price pressures have continued to ease, with wages growing more slowly. Partly reflecting the Governing Council s past interest rate cuts, the economy has so far proven resilient overall in a challenging global environment. At the same time, the environment remains exceptionally uncertain, especially because of trade disputes. The Governing Council is determined to ensure that inflation stabilises at its 2% target in the medium term. 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 and the risks surrounding it, in light of the incoming economic and financial data, as well as 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 In the first quarter of 2025 the economy grew more strongly than expected. This was partly because firms frontloaded exports ahead of expected tariff hikes. But growth was also bolstered by stronger private consumption and investment. Recent surveys point to an overall modest expansion in both the manufacturing and services sectors. At the same time, higher actual and expected tariffs, the stronger euro and persistent geopolitical uncertainty are making firms more hesitant to invest. The robust labour market, rising real incomes and solid private sector balance sheets continue to support consumption. Unemployment stood at 6.3% in May, close to its lowest level since the introduction of the euro. Easier financing conditions are underpinning domestic demand, including in the housing market. Over time, higher public investment in defence and infrastructure should also support growth. More than ever, the Governing Council considers it crucial to urgently strengthen the euro area and its economy in the present geopolitical environment. Fiscal and structural policies should make the economy more productive, competitive and resilient. Governments should prioritise growth-enhancing structural reforms and strategic investment, while ensuring sustainable public finances. It is important to complete the savings and investments union and the banking union, following a clear Economic Bulletin Issue 5 / 2025   Economic, financial and monetary developments Summary 3 and ambitious timetable, and to rapidly establish the legislative framework for the potential introduction of a digital euro. The Governing Council welcomes the Eurogroup s commitment to improve the effectiveness, quality and composition of public spending and supports the efforts by European authorities to preserve the mutual benefits of global trade. Inflation Annual inflation stood at 2.0% in June 2025, after 1.9% in May. Energy prices went up in June but are still lower than in 2024. Food price inflation eased slightly to 3.1%. Goods inflation edged down to 0.5% in June, whereas services inflation ticked up to 3.3%, from 3.2% in May. Indicators of underlying inflation are overall consistent with the Governing Council s 2% medium-term target. Labour costs have continued to moderate. Year-on-year growth in compensation per employee slowed to 3.8% in the first quarter of 2025, down from 4.1% in the fourth quarter of 2024. Combined with stronger productivity growth, this led to slower growth in unit labour costs. Forward-looking indicators, including the ECB s wage tracker and surveys on wage expectations of firms, consumers and professional forecasters, point to a further decline in wage growth. Short-term consumer inflation expectations declined in both May and June, reversing the uptick observed in previous months. Most measures of longer-term inflation expectations continue to stand at around 2%, supporting the stabilisation of inflation around the Governing Council s target. Risk assessment Risks to economic growth remain tilted to the downside. Among the main risks are a further escalation in global trade tensions and associated uncertainties, which could dampen exports and drag down investment and consumption. A deterioration in financial market sentiment could lead to tighter financing conditions and greater risk aversion, and make firms and households less willing to invest and consume. Geopolitical tensions, such as Russia s unjustified war against Ukraine and the tragic conflict in the Middle East, remain a major source of uncertainty. By contrast, if trade and geopolitical tensions were resolved swiftly, this could lift sentiment and spur activity. Higher defence and infrastructure spending, together with productivity-enhancing reforms, would add to growth. An improvement in business confidence would also stimulate private investment. The outlook for inflation is more uncertain than usual, as a result of the volatile global trade policy environment. A stronger euro could bring inflation down further than expected. Moreover, inflation could turn out to be lower if higher tariffs lead to lower demand for euro area exports and induce countries with overcapacity to reroute their exports to the euro area. Trade tensions could lead to greater volatility and risk aversion in financial markets, which would weigh on domestic demand and would Economic Bulletin Issue 5 / 2025   Economic, financial and monetary developments Summary 4 thereby also lower inflation. By contrast, inflation could turn out to be higher if a fragmentation of global supply chains pushed up import prices and added to capacity constraints in the domestic economy. A boost in defence and infrastructure spending could also raise inflation over the medium term. Extreme weather events, and the unfolding climate crisis more broadly, could drive up food prices by more than expected. Financial and monetary conditions Market interest rates have increased since the Governing Council s monetary policy meeting in June 2025, especially at longer maturities. At the same time, the Governing Council s past interest rate cuts continue to make corporate borrowing less expensive. The average interest rate on new loans to firms declined to 3.7% in May, from 3.8% in April. The cost of issuing market-based debt also came down, falling to 3.6% in May. While the growth rate of loans to firms moderated to 2.5% in May, corporate bond issuance was stronger, growing at a rate of 3.4% in annual terms. Credit standards for business loans were broadly unchanged in the second quarter of 2025, as reported in the July 2025 bank lending survey for the euro area. While banks  concerns about the economic risks faced by their customers had a tightening impact on credit standards, this was broadly offset by stronger competition among lenders. Meanwhile, firms  demand for credit increased slightly, benefiting from lower interest rates, but they remained cautious because of global uncertainty and trade tensions. The average interest rate on new mortgages has barely changed since the start of 2025 and stood at 3.3% in May. Growth in mortgage lending edged up to 2.0% in May, in the context of a strong increase in demand, while credit standards tightened slightly in the second quarter. Monetary policy decisions The interest rates on the deposit facility, the main refinancing operations and the marginal lending facility remain unchanged at 2.00%, 2.15% and 2.40% respectively. The APP and PEPP portfolios are declining at a measured and predictable pace, as the Eurosystem no longer reinvests the principal payments from maturing securities. Conclusion At its meeting on 24 July 2025, the Governing Council decided to keep the three key ECB interest rates unchanged. The Governing Council is determined to ensure that inflation stabilises at its 2% target in the medium term. It will follow a data-dependent and meeting-by-meeting approach to determining the ap