OECD Economic Outlook, Volume 2024 Issue 1

Euro area

GDP growth is projected to remain weak, at 0.7% in 2024, and pick up to 1.5% in 2025 as domestic demand recovers. Private consumption will be supported by wage increases in tight labour markets and increasing real incomes as inflation recedes. Investment will benefit from a gradual easing of credit conditions and ongoing disbursement of the Recovery and Resilience Facility funds. Wage growth is projected to ease over the projection period, as employment bottlenecks in services moderate, helping core inflation to reach 2% by mid-2025.

Fiscal policy will tighten in 2024 and 2025 as energy support measures are gradually withdrawn. Prudent fiscal policy is needed to rebuild fiscal space and complement the gradual relaxation of the monetary policy stance as inflation returns to target. Fiscally prudent policy under the new European fiscal rules will centre on debt sustainability and multiannual expenditure plans.

The economy remains resilient amid elevated geopolitical uncertainty

GDP remained flat in the last quarter of 2023, mainly reflecting subdued household consumption and weak export growth. Elevated geopolitical tensions continue to contribute to uncertainty. Forward‑looking indicators of sentiment and confidence remain at levels consistent with mild output declines, despite improvements in the composite PMI in March and April, primarily in services. Headline inflation continued to moderate from 2.6% in February to 2.4% in March. Similarly, core inflation decreased from 3.1% in February to 2.9% in March. However, underlying inflation remains sticky with services prices rising by 4% in annual terms, adding to the underlying pressures. However, market-based inflation expectations have eased at all horizons and stabilised at the 2% target from 2025 onwards. At the same time, the labour market has remained tight, with employment expectations among businesses above the long-term average. The euro area seasonally adjusted unemployment rate stood at 6.5% in February, stable compared with January, with labour shortages reflected in continuing robust wage growth in many countries.

Euro area: Labour market and inflation indicators

Source: OECD Quarterly National Accounts database; Eurostat Unemployment rates by sex, age, citizenship 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: Fiscal and monetary indicators

1. Maastricht definition.

2. The policy interest rate shown for the euro area is the deposit facility rate (DFR).

Source: OECD Economic Outlook 115 database.

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There was a trade surplus in February 2024, supported by steadily improving economic activity outside the euro area. While services trade recovered, merchandise trade continued to be affected by tight financial conditions and elevated geopolitical tensions. However, the economic fallout in the euro area from Russia’s war of aggression against Ukraine has moderated. Energy commodity prices have decreased, with a reduction in demand for natural gas and a strong increase in new installed capacity in renewables in the power sector. At the same time, output in the most energy-intensive industries has continued to decline, weighing on growth. Financial conditions have eased although euro area credit standards remain tight and demand for loans has declined, reflecting high interest rates, subdued consumer confidence and weaker housing markets. Moreover, business bankruptcies have risen towards or above pre‑pandemic levels in some countries. EU countries have accorded temporary protection to more than 4 million Ukrainian refugees until March 2025 and the EU has started to disburse funds from the Ukraine Facility, which will provide EUR 50 billion (0.5% of euro area GDP) until 2027 in grants and loans for reconstruction and modernisation.

Macroeconomic policy will remain restrictive

Although fiscal positions differ significantly across countries, the aggregate euro area fiscal stance is projected to remain restrictive in 2024 and, to a lesser extent, in 2025, with cumulative tightening amounting to 1½% of GDP. Fiscal support to cushion the impact of high energy costs is projected to be gradually withdrawn during 2024. New EU fiscal rules will provide incentives for structural reforms, while introducing safeguards to ensure medium-term fiscal sustainability. At the same time, the war in Ukraine has led to an ongoing increase in military spending and the Next Generation EU (NGEU) programme has triggered investments to ensure energy security and accelerate the green transition, amounting to about 1% of euro area GDP per year. This spending, given supply-side constraints in many countries, needs to be delivered effectively.

The ECB has kept a restrictive monetary policy stance, with the deposit facility rate at 4%. The policy rate is projected to stay at this level until the third quarter of 2024. The deposit facility rate is then projected to gradually decline to 2.5% at the end of 2025, with policy remaining restrictive for some time to durably reduce underlying inflation pressures. A period of below-trend growth will help lower resource pressures, including from buoyant labour markets and the short-term inflationary effects of additional public expenditure associated with the NGEU programme. Public investment is estimated to increase by as much as 2.5% of GDP by the end of the NGEU programme in 2026, crowding in private investment possibly amounting to 5% of GDP over time.

Growth will strengthen in 2025 as domestic demand picks up

Growth is projected to rebound gradually, amid easing financial conditions, supported by benign energy and commodity prices, and reduced uncertainty. The labour market will remain tight, with historically low unemployment supporting strong wage growth. Real wage growth and resilient employment will support a rebound in consumption, as disinflation continues over the projection period. Investment will be supported by more benign financing conditions and additional spending under the NGEU programme. Headline inflation is projected to moderate further, to 2.3% in 2024 and 2.2% in 2025, as cost pressures moderate. Core inflation is also projected to decline, returning to the ECB inflation target by the middle of 2025.

The risks to the projections are to the downside. An aggravation of geopolitical tensions, such as an escalation of conflict in the Middle East, could weigh on external demand. Higher transport costs resulting from Red Sea shipping disruptions could add to inflationary pressures. Financial stability risks remain elevated in the euro area, as the number of bankruptcies increases, and high interest rates could trigger losses from non-performing loans and real estate exposures. Moreover, policy interest rates may need to stay high for longer than expected, weighing on the recovery. On the upside, a stronger decline in elevated household saving rates would strengthen private consumption. In addition, a durable reduction of geopolitical uncertainty could hasten disinflation and, together with a stronger recovery in China, could help lift external demand.

Macroeconomic policies should remain prudent

The investment needs associated with improvements in energy security and ongoing decarbonisation policies are substantial. At the same time, prudent fiscal policy is needed to support the monetary policy stance and continue rebuilding fiscal space. Effective disbursement of the Next Generation EU funds will help expand productive capacity in the medium term but requires careful design and monitoring at the EU level. To avoid harmful subsidy races and ensure a level playing field, state-aid rules should not be relaxed further, and existing EU budgetary resources should be re-directed towards support for green R&D, innovation and early-stage support coordinated at the EU level. The monetary policy stance should not be relaxed prematurely and be complemented, as needed, by macroprudential policy measures and the use of targeted instruments to address potential vulnerabilities in the financial sector.