OECD Economic Outlook, Volume 2025 Issue 1

Euro area

GDP growth is projected to strengthen to 1% in 2025 and 1.2% in 2026 as foreign demand recovers. Private consumption will be supported by sustained growth of real disposable incomes. Private investment will be constrained by high uncertainty but will benefit from improved financing conditions; public investment will be supported by the Recovery and Resilience Facility funds. Wage growth is projected to ease gradually, helping core inflation to return to 2% by the second half of 2025.

Fiscal policy will tighten in 2025 and remain broadly neutral in 2026, as countries make use of the national escape clauses under the new fiscal rules. Although defence spending is set to rise and debt financing could be required in the short term, prudent fiscal policy is needed to ensure medium-term fiscal sustainability. Monetary policy should remain prudent to ensure that inflation is durably reduced to target. Reducing regulatory burdens on labour mobility would help alleviate labour shortages, while progress on financial integration could boost cross-border financial flows, lifting private investment. The economy remains resilient amid increasing global uncertainty.

The economy remains resilient amid high uncertainty

GDP grew by 0.3% quarter on quarter in the first quarter of 2025. Recent indicators suggested some rebound in the economy, but the composite PMI declined in May, reflecting weakening in services and only modestly improving activity in manufacturing. Headline inflation stood at 2.2% in April, unchanged from March. Core inflation increased to 2.7% in April, from 2.4% in March, partly driven by the timing of Easter, but market and survey-based inflation expectations have remained broadly stable at the 2% target since December 2024. Services inflation also increased in April, to 4% in annual terms, up from 3.5% in March. The labour market is gradually normalising, with both employment growth and nominal wage growth slowing in the fourth quarter of 2024. At the same time, the euro area seasonally adjusted unemployment rate remained low at 6.2% in March. Financial conditions continue to be mildly restrictive, with the corporate demand for loans decreasing, but a continuing rebound in housing loans and other lending to households. The number of bankruptcies fell slightly in the fourth quarter of 2024, from a high level in the first half of the year.

Benign energy prices and increasing exports of chemicals and manufactured goods brought the goods trade surplus to EUR 44 billion or 0.3% of euro area GDP in March. Exports were affected by front-loading amid growing trade frictions and elevated geopolitical tensions. At the same time, the balance of services trade remained positive, and the current account surplus for the last 12 months increased to 2.9% of GDP in March. Energy commodity prices have decreased, but the recovery from the recent energy price shock has been uneven, with output and profits of energy-intensive firms decreasing. The US has introduced a 10% tariff on imports of EU goods, with a 25% tariff on imports of steel and aluminium and cars and car parts. The EU postponed its countermeasures for 90 days in April. In support of Ukraine, EU countries have extended temporary protection to more than 4 million Ukrainian refugees until March 2026, helping to reduce labour shortages in certain sectors. The EU has disbursed almost EUR 20 billion (0.1% of euro area GDP) from the EUR 50 billion Ukraine Facility and approved an additional loan of up to EUR 35 billion (0.2% of euro area GDP), financed by proceeds from frozen Russian assets.

Euro area 1

1. The job vacancy rate measures the proportion of total posts that are vacant, expressed as the ratio of the number of job vacancies to the number of occupied posts plus the number of job vacancies.

Source: Eurostat Job vacancy statistics database; OECD Economic Outlook 117 database; and Eurostat Harmonised index of consumer prices (HICP) database.

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Euro area: Demand, output and prices

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Euro area 2

1. Gross general government interest payments.

2. Maastricht definition.

Source: OECD Economic Outlook 117 database.

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Macroeconomic policy is to become less restrictive

The aggregate euro area fiscal stance is projected to tighten by about ¼% of GDP in 2025 and remain broadly unchanged in 2026. The fiscal measures to stem the effects of the energy crisis have been withdrawn, while spending under the NextGenerationEU (NGEU) programme could provide support of about 1% of GDP in 2025 and 2026. Russia’s war of aggression against Ukraine has triggered additional military spending and the EU fiscal rules were relaxed by allowing the coordinated use of national escape clauses for up to 1.5% of GDP per year for defence purposes, enabling additional spending of about EUR 650 billion (4.3% of euro area GDP) over the next four years. In addition, the Security Action for Europe (SAFE) instrument will allow EU countries to borrow up to EUR 150 billion to facilitate the increase in defence spending.

The European Central Bank’s monetary policy stance has become less restrictive, as the deposit facility rate has been cut by a cumulative 175 basis points since June 2024, to 2.25% in April 2025. The policy rate is projected to decrease further, reaching 1.75% in the latter part of 2025. While the interest rate cuts will support aggregate demand, the overall policy stance is projected to remain cautious for some time to durably reduce inflation to the 2% target. The short-term inflationary pressures stem from labour shortages and additional public expenditure under the NGEU programme, estimated to total 2.5% of GDP by end‑2026.

Economic growth will strengthen as domestic demand picks up

Growth is projected to strengthen, supported by easing financial conditions and lower energy prices. The labour market will remain tight, with labour shortages in some occupations and historically low unemployment slowing down wage growth normalisation. Growing real disposable incomes will support consumption, albeit at a slowing rate as disinflation comes to an end. Elevated uncertainty related to trade tensions will weigh on private investment, but public investment will be supported by spending under the NGEU programme. Headline inflation is projected to moderate further, as labour cost pressures gradually dissipate. Core inflation is also projected to decline, returning to the level consistent with the ECB inflation target by mid-2026.

Risks to the projections are tilted to the downside. Worsening trade tensions, such as an increase in US reciprocal tariffs and possible EU countermeasures, would weigh on external demand, while the tariffs already in place could trigger unfavourable trade diversion flows towards the euro area. Trade retaliation measures by the EU could add to inflationary pressures. Financial stability risks continue to exist in the euro area, with pockets of financial vulnerabilities in the commercial real estate and nonbanking financial sector. On the upside, a stronger use of accumulated household savings could strengthen private consumption. In addition, a durable reduction of geopolitical uncertainty and trade tensions could hasten disinflation and help lift external demand.

Structural reforms are needed to complement prudent macroeconomic policies

The investment needs associated with defence, energy security and decarbonisation are considerable. While defence spending is set to rise, it should not be financed by debt issuance in the long term. Reprioritisation of fiscal spending and prudent fiscal policy will be needed to rebuild fiscal buffers and address other spending pressures, such as population ageing. Effective disbursement of the NGEU funds will help expand medium-term productive capacity but it is associated with short-term inflationary risks that need to be monitored at the EU level. The new EU fiscal rules encourage structural reforms and safeguards for medium-term fiscal sustainability, but the impending activation of the national escape clauses may further delay reduction of existing excessive deficits. To ensure a level playing field and effective use of public funds, state-aid rules should not be relaxed further. The monetary policy stance should not be eased prematurely and macroprudential instruments should be used to address potential financial sector vulnerabilities. Furthermore, labour shortages could be alleviated by attracting high‑skilled non‑EU workers and by reducing regulatory and administrative burdens on intra-EU mobility. Finally, progress on the Capital Markets Union and the banking union could help boost cross-border financial flows, lifting private investment.