OECD Economic Outlook, Volume 2024 Issue 1

Luxembourg

Real GDP is projected to grow by 1.4% in 2024 and 2.6% in 2025. The main driver of growth will be private consumption, as rising nominal wages and receding inflation support households’ real disposable income. Exports are expected to strengthen on the back of growing demand from euro area trading partners, whereas investment is projected to remain weak in 2024, mainly due to the downturn in construction. Risks are moderately to the downside. A larger-than-expected and more persistent downturn in the housing market could lead to a weaker recovery in activity, while an earlier-than-expected easing of global financial conditions could boost activity, especially in the financial sector.

The stance of fiscal policy in 2024 will be mildly restrictive. The partial phase-out of energy policy support more than offsets the reduction in personal income taxes from the adjustment of tax brackets to inflation. To maintain low public debt, energy policy support should be fully unwound in 2025. In the medium term, the authorities should address long-term fiscal pressures stemming from the pension system and reduce work disincentives due to the joint taxation of couples.

Economic activity has continued to contract

Real GDP in the fourth quarter of 2023 was almost 3% lower than at the end of 2021, as tighter financial conditions have weakened financial sector activity and housing investment. By contrast, household consumption has been robust, as three rounds of wage indexation and fiscal measures to tackle the energy crisis have supported household incomes. After deteriorating since early 2022, consumer and business sentiment ticked up modestly since the end of 2023, especially in industry, retail and non-financial services. Manufacturing production and construction activity remain weak but appear to have bottomed out.

Luxembourg: Economic growth and activity indicators

1. Year-on-year percentage changes.

Source: OECD Economic Outlook 115 database; and OECD National accounts database.

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Luxembourg: Demand, output and prices

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Exports declined over 2022-23, as activity in key euro area trade partners slowed and tighter global financial conditions negatively affected demand for financial services. Inflation has eased after the peak reached in 2022, as commodity and energy prices have fallen, and was 3.2% in March.

Fiscal policy will be mildly restrictive

Fiscal support to tackle the energy crisis has partially been withdrawn, but most measures, including price support measures, remain in place until the end of 2024. Reduced public expenditure on energy policy support more than offsets a reduction in personal income taxes stemming from the adjustment of tax brackets to inflation, resulting in a mildly tighter fiscal stance in 2024. In 2025, further scaling back of energy policy support will broadly be offset by the projected increase in public investment. The headline government budget deficit will be around 1% of GDP in both 2024 and 2025. While the fiscal stance appears broadly appropriate, energy policy support, especially price support measures, should be fully unwound in 2025.

Activity will recover over 2024-25

Growth is projected to strengthen gradually over 2024-25. As financial conditions ease, the performance of the financial sector will improve, and exports will be supported as economic activity in the euro area picks up. Private consumption is projected to grow robustly as disposable income is bolstered by two further rounds of wage indexation in 2024 and 2025. The projected decline in borrowing costs will benefit investment, but the construction sector is expected to recover only gradually. Inflationary pressures will slowly dissipate as the unemployment rate increases, but headline inflation will pick up in 2025 as energy price support comes to an end. Risks are moderately to the downside, with a larger‑than‑expected and more persistent downturn in the housing market as the main downside risk. A stronger recovery in the euro area and a faster easing of global financial conditions are key upside risks.

Restoring growth and maintaining low public debt are key challenges

In the medium term, the authorities face the dual challenge of restoring growth and maintaining low public debt. At below 30% of GDP, public debt is low in international perspective, but maintaining fiscal buffers is key to be able to respond to negative shocks to which a small open economy such as Luxembourg might be particularly exposed. A key issue will be to strengthen productivity growth, including by providing labour-market relevant adult learning opportunities, attracting and retaining foreign talent, and revising public support to research and development. Labour market participation could be boosted by enhancing active labour market policies and revising the system of joint taxation of couples, which reduces work incentives for second earners. Reform measures, such as limiting early retirement and linking the legal retirement age to life expectancy, will be needed to address the deficit in the public pension scheme that is projected to emerge in 2027 and that will rapidly increase over subsequent decades.