In a nutshell
The trade agreement with the US paves the way for an upturn in the eurozone at the end of the year.
The mood in Germany has brightened somewhat recently. Now it is up to the government to deliver.
Trump's policies are weighing on growth and complicating the work of the Fed.
Europe: Upswing expected for the end of the year
After real gross domestic product in the eurozone rose by 0.6% in the first quarter of 2025 compared with the previous quarter, the economy grew by only 0.1% in the second quarter. One of the reasons for this is that the stronger growth in the first three months of the year was based on an increase in exports. Companies wanted to pre-empt the impending US tariffs. In return, exports were weaker in the second quarter, weighing on gross domestic product.
The trade agreement concluded in August between the US and the European Union (EU) provides for tariffs of 15% on most imports from the EU to the US. Tariffs on US industrial goods, on the other hand, are to be reduced to zero. In addition, the EU has committed itself to importing US energy and making investments. Although the trade agreement can be criticised as unbalanced, the alternative of a bitter trade war between the EU and the US would have been far worse – both for the economy and for geopolitics.
The trade agreement ends the uncertainty and, following a third quarter that is expected to be even weaker, could serve as a catalyst for an incipient upturn in the eurozone in the final quarter. This is also indicated by the purchasing managers' index for the eurozone, which in August was above the 50-point threshold signalling growth for the eighth month in a row. Meanwhile, the labour market remains stable: the unemployment rate falling to 6.2% in July, reaching a historical low. The ECB's monetary easing and the German government's extensive fiscal package are expected to provide additional tailwinds. The biggest risk to the upturn currently comes from France, where political instability and rising debt are increasingly seen as a significant threat, not least on the financial markets.
The ECB's loose monetary policy is having an effect
Growth in mortgage loans compared to the previous year, in %
Germany: The mood has brightened somewhat recently
The German economy contracted more sharply in the second quarter than previously assumed. GDP fell by 0.3% between April and June compared with the previous quarter. An initial estimate had predicted a decline of only 0.1%. Similar to the eurozone as a whole, the advance effects on exports in the first quarter were followed by a setback in the second quarter. Overall, this means that the first half of the year saw stagnation. For the third quarter, the slightly improved ifo business climate, the rise in purchasing managers' indices and the increase in new orders point to slight growth. Towards the end of the year, the German government's extensive spending package is likely to have an impact on the real economy, with the economy expected to gain some momentum from the fourth quarter onwards. The mood in the country – and thus the economy – would also benefit if the government argued less and delivered more. The coalition has achieved a great deal, but it would be desirable to see more progress in dismantling regulations. In addition, signals that the government will also tackle genuine reforms in pensions and care in order to curb rising social spending would be welcome. So far, this has been almost completely lacking.Order books in Germany are slowly filling up again
Order backlog in the manufacturing sector
US: A hint of stagflation
In recent months, the White House has concluded several trade agreements and agreed with China to extend the tariff pause until 10 November. An agreement is expected to follow. Despite everything we expect the average US tariff to be around 18% in the future. That would be about seven times higher than at the beginning of Trump's second term. The high tariffs will cause inflation to rise further and put pressure on US consumers. The US government's restrictive immigration policy, which significantly limits the supply of labour, is also having a dampening effect on the economy. Overall, economic momentum in the US appears to be slowing, while prices continue to rise. Added to this is the increasing erosion of institutions by the US government, which will undermine the attractiveness of the US as a business location over time. We expect trend growth in the US to decline from 2.0% to 1.5%.
Fed in a quandary, ECB in a comfortable position
The Fed is currently in a difficult position. On the one hand, the labour market in the US is cooling down and, on the other hand, the increased tariffs are slowly becoming noticeable in prices. Core inflation remained at 3.1% in August. The increased import duties are expected to push inflation even further away from the Fed's 2% target in the coming months. At present, the Fed appears to be more concerned about the labour market than the risk of inflation. On 17 September, the Fed lowered its key interest rate by 25 basis points to 4.00-4.25%. On 30 October, the Fed is expected to follow up with another interest rate cut of the same magnitude. However, due to ongoing inflationary pressure, this will probably be the last interest rate move.
In contrast to the Fed, the European Central Bank (ECB) is in a very comfortable position. Although the inflation rate rose slightly from 2.0% to 2.1% in August, overall, the ECB's assessment that inflation in the eurozone is under control has been confirmed. Meanwhile, the tariff fog has lifted somewhat and sentiment indicators point to an economic upturn at the end of the year. The ECB therefore left the deposit rate unchanged at 2.0% at its meeting on 11 September, and we do not expect any further interest rate cuts. In the medium term, the ECB is likely to be forced to raise its key interest rate again slightly from the mid of 2027 onwards in view of expansionary fiscal policy (especially in Germany) and wage cost inflation due to demographic change. We expect the deposit rate to reach 3.0% by the beginning of 2028.
Growth and inflation forecasts
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