The euro area economy is poised to outperform earlier estimates in 2025, according to the latest projections from the European Commission. Revised forecasts suggest that gross domestic product (GDP) across the 20 countries sharing the euro may expand by around 1.3% next year—up from previous guidance of 0.9%—as a rebound in exports and gradually easing inflation combine to lift growth prospects. While the pace remains modest by historic standards, the upward revision signals a growing confidence in the region’s ability to navigate external headwinds and structural constraints. Underlying the improvement are several factors: stronger-than-anticipated export demand ahead of trade policy shifts, improved financing conditions for business and households, and signs of inflation moderating toward the European Central Bank’s target. The question now is whether this uptick represents a durable shift or remains a temporary wind-in-the-sails phenomenon.

Export-Led Upside and External Resilience

At the heart of the revised growth outlook lies a stronger export performance than previously forecast. Companies across the euro zone appear to have front-loaded shipments in anticipation of tariff and trade-policy adjustments, generating a surge in external demand that bolstered manufacturing and intermediate-goods production. Firms in Germany, the Netherlands and Austria reported higher order books and improved delivery times, particularly in capital-goods and vehicle-components sectors. This export momentum not only offset some of the drag from sluggish consumption growth but also reinforced industrial sentiment at a time when global demand remains uneven.

The export strength is particularly noteworthy given the global climate of elevated risks—ranging from Asian slowdown to U.S. monetary tightening. That the euro area could deliver upward surprises in exports suggests that the region’s trade linkages, logistical networks and competitiveness improvements are paying off. Indeed, several factors support this rebound: a weaker euro relative to earlier projections, enabling better price competitiveness for euro-area goods; increased near-shoring of production within Europe by multinationals; and companies revisiting supply-chain diversification in favour of European bases rather than depending exclusively on Asia. Together, these structural shifts have added robustness to the outlook.

Nevertheless, the export boost should be viewed with nuance. While the immediate front-loading of orders improved 2025 data, the durability of that momentum remains uncertain. Some cyclical inventory rebuild and acceleration in delivery backlogs may fade in 2026, which explains the Commission’s forecast of a slight growth slowdown to 1.2% next year. Moreover, exports alone cannot sustain growth: domestic demand will need to re-energise for a self-sustaining recovery. But for now, the export channel has offered the euro zone a welcome bit of breathing room.

Domestic Engines and Inflation Dynamics

While exports provide an important tailwind, the euro-zone growth story is also shaped by underlying domestic dynamics. Consumers and businesses are benefiting from improving financing conditions: borrowing costs for European households and small-to-medium enterprises have begun to ease as the European Central Bank shifts away from its most aggressive tightening phase. Lower interest-rate pressures reduce the drag on debt servicing, which supports disposable incomes and investment decisions. In housing, construction starts in several countries have picked up modestly after a prolonged slump, while business investment is showing early signs of stabilising as firms emerge from uncertainty.

Inflation is another piece of the puzzle. The Commission projects consumer price growth to slow to roughly 2.1% in 2025 and 1.9% in 2026, down from 2.4% in 2024. This moderation helps real incomes, consumer confidence and wage negotiation dynamics—all of which matter for domestic spending. The ECB’s current inflation-targeting regime, combined with the easing of energy-price shocks experienced in recent years, underpins this improvement. As inflation pressures ease, the risk of recession-inducing rate-hikes by central banks falls, enhancing stability in the growth outlook.

Despite these positives, domestic demand is not yet firing on all cylinders. Labour markets in many euro-zone countries remain tight, but wage growth has not yet accelerated broadly enough to trigger a consumption-led boom. Governments continue to grapple with structural issues such as productivity stagnation, ageing populations and weak investment in innovative sectors. Public-sector deficits and high debt levels in some economies (including Italy and Greece) continue to weigh on fiscal flexibility. Nonetheless, the combination of stronger exports, moderating inflation and improving monetary conditions provides a plausible basis for growth to exceed earlier expectations in 2025.

Fiscal Landscape, Risks and Outlook for 2026-27

An important dimension of the Commission’s forecast is the interplay between growth, fiscal policy and debt. While growth is expected to edge up in 2025, the aggregated budget deficit across the euro area is projected to widen: from 3.1% of GDP in 2024 to about 3.2% in 2025, rising further to 3.3% in 2026 and 3.4% in 2027. Concurrently, the euro-zone debt burden is expected to climb from 88.1% of GDP in 2024 to 88.8% in 2025, and then to 89.8% in 2026 and 90.4% in 2027. The widening fiscal figures reflect higher defence and climate-investment spending, slowing revenue growth in some economies, and the structural costs of ageing populations and health care.

The interplay between stronger growth and expanding deficits highlights the structural tension policymakers face. On the one hand, improved growth reduces the debt-to-GDP ratio’s denominator effect, but rising deficits increase the numerator. Countries such as Germany anticipate their budget gap increasing to roughly 4.0% of GDP next year, mainly due to elevated defence commitments. France expects to reduce its gap from 5.8% in 2024 to 5.5% in 2025, and further down to 4.9% in 2026, despite ongoing political instability. These diverging national fiscal pathways raise questions about how resilient the zone-wide improvement really is.

Looking ahead, the Commission sees growth decelerating slightly to 1.2% in 2026 before climbing again to 1.4% in 2027. This pattern reflects the expectation that the front-loaded export surge will fade, and the broader growth impulse must shift toward domestic investment, structural reforms and productivity improvement. The region remains exposed to several risks: a sharper-than-expected slowdown in China; renewed energy-price shocks; faster-than-anticipated monetary-tightening by global central banks; and geopolitical tensions disrupting trade or supply-chains. The relatively modest growth numbers underline that while the revision is positive, the euro-zone geostrategic and structural headwinds remain significant.

In essence, the revised Commission forecast for faster-than-expected 2025 growth in the euro zone is anchored in stronger exports, easing inflation and improving financing conditions. However, the sustainability of this improved outlook will depend on how quickly domestic demand and investment recover, and whether fiscal pressures remain manageable. The next two years may prove to be less about catching up and more about building the foundation for long-term structural resilience.

(Adapted from Politico.eu)

Categories: Economy & Finance, Regulations & Legal, Strategy