Fiscal policy to slow growth in 2025 – But mind the RFF

Danske Research Team Danske Bank A/S

Fiscal policy in the euro area is set to tighten in 2025 as governments cut back national spending to comply with EU fiscal rules. We project the public budget deficit in the euro area to decline from 3.5% of GDP in 2024 to 2.9% 2025 due to active tightening of national fiscal policies. The consolidation of public finances comes at a time when the euro area economy is faced with a deteriorating economic outlook and risks of increased unemployment. An important question for the economic outlook is thus how much a drag on growth the fiscal tightening of public finances will be next year?

The draft budgets for 2025 submitted to the Commission in mid-October show how governments intent to cut public spending next year. Part of the consolidations are due to the final phase-out of crisis related measures while other discretionary measures are made to comply with the new EU fiscal rules. To gauge the magnitude of the discretionary changes in next year’s fiscal policy we look at the change in the cyclically adjusted primary balance (CAPB). We estimate that the euro area will experience an active fiscal tightening of national polices of 0.7 percentage points of potential GDP in 2025. The tightening is especially driven by France and Germany that project a change in the CAPB of + 1.3 p.p and + 0.8 p.p, respectively, while Spain and Italy both forecast a change of + 0.5 p.p. The tightening is set to slow growth as it is the biggest seen in more than ten years when excluding the previous years after COVID. However, the exact impact on growth is uncertain and subject to the specific fiscal consolidation measure chosen and its horizon.

EU grants from RFF to partially counter national tightening

While the effect of national fiscal policies in the euro area is set to slow growth next year, it is partially countered by increased EU grants under the RRF programme. We estimate the RRF grants to ease the fiscal stance with 0.4 p.p of potential GDP, meaning the overall tightening of the fiscal stance is 0.3 p.p. Hence, the overall impact of fiscal policy on growth is only slightly contractionary next year. The RRF programme has a total amount of EUR 177 bn left in grants for 2025 and 2026, corresponding to 1% of EU GDP. In Italy, revenue from RFF grants is projected to increase from 0.3% of GDP to 0.6% in 2025, and in Portugal from 1.3% to 2.3% of GDP while German and French receipts are set to remain at 0.1% and 0.2% of GDP, respectively. We thus estimate the sum of the national and EU fiscal policy change to be clearly contractionary in France and Germany, neutral in Spain and Italy, and even expansionary in Portugal. Hence, fiscal policy next year is set to amplify the growth divergence that have been observed recently between Southern Europe and Germany and France, see Research euro area - Southern Europe to continue outperforming, 23 September.

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Danske Research Team

Danske Bank A/S

Research is part of Danske Bank Markets and operate as Danske Bank's research department. The department monitors financial markets and economic trends of relevance to Danske Bank Markets and its clients.

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