European Central Bank easing to slow as Eurozone outlook brightens

Summary

• The Eurozone economy showed a degree of resilience late last year, though some notable policy developments in early 2025 have since had some significant implications for the region's medium-term outlook. The likelihood of higher tariffs of imports from the European Union should restrain Eurozone growth in 2025, and our GDP growth forecast is unchanged at 0.8%. However, landmark fiscal stimulus from Germany has in our view brightened prospects for both Germany and the broader Eurozone, prompting us to raise our 2026 Eurozone GDP growth forecast to 1.6%.

• A brighter and more balanced medium-term outlook for the Eurozone means we also now expect a less dovish monetary policy approach from the European Central Bank (ECB). With downside growth risks lessening, and inflation pressures still easing relatively gradually, we expect even more careful and considered deliberations by ECB policymakers at upcoming meetings. We now forecast 25 bps ECB rates cuts in June and September (that is, every other meeting). That would see the ECB's policy rate reach a low of 2.00% by September, compared to our previous outlook for a policy rate low of 1.75%.

• A firmer medium-term growth outlook and less dovish European Central Bank also has implications for the outlook for the European currency, especially when juxtaposed against our evolving U.S. outlook which sees softer GDP growth in 2025, and slightly faster Fed easing this year. We now expect only a gradual pace of euro depreciation over time, targeting a EUR/USD exchange rate of $1.02 by Q3-2026.

Eurozone's economic landscape evolving, medium-term prospects brightening

The Eurozone economy showed a degree of resilience late last year, offering some encouragement that the region's recovery could gather further momentum in 2025. In the early part of this year, however, there have been some notable policy developments, with significant implications for the Eurozone outlook. The increasing threat of tariffs from the United States could weigh on growth this year, but the prospect of more expansive fiscal policy in Germany has, in our view, improved the region's medium-term growth outlook. Our forecast for Eurozone GDP growth for 2025 is unchanged at 0.8%, while we have revised our forecast for Eurozone 2026 GDP growth higher to 1.6%.

Eurozone GDP rose a moderate 0.2% quarter-over-quarter in Q4-2024 though, with upward revisions to prior quarters, that helped boost growth to 1.4% year-over-year. For the fourth quarter specifically, the expansion in economic activity was quite broad-based, as household consumption rose 0.4% quarter-over-quarter, government consumption also rose 0.4%, and investment spending rose 0.6%. The increase in investment spending was also notable in that it included an increase in core ex-housing investment (that is, excluding the volatile intellectual property products component). For now, growth in employee compensation and household disposable income continues to run ahead of consumer spending, suggesting there remains room for a further modest consumer recovery over the course of this year. The near-term outlook for investment spending is more mixed, however, given softening corporate profits and still-low levels of manufacturing capacity utilization.

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