GDP growth is projected to strengthen from 0.8% in 2024 to 1.3% in 2025 and 1.5% in 2026, on the back of recovering domestic demand. Private consumption will be supported by wage increases in buoyant labour markets and sustained growth of real disposable incomes. Private investment will benefit from more favourable credit conditions, and public investment will be supported by the Recovery and Resilient Facility funds. Wage growth is projected to ease gradually, as labour cost pressures moderate, helping core inflation approach 2% in the second half of 2025.

Fiscal policy will tighten in both 2025 and 2026, as energy and inflation support measures are withdrawn and countries adopt consolidation measures under the new fiscal rules. Prudent fiscal policy is needed to rebuild fiscal buffers and support the ongoing relaxation of the monetary policy stance as inflation returns to target. The new European fiscal rules provide a policy framework centred on debt sustainability and multiannual expenditure plans. Monetary policy should not be relaxed prematurely to ensure that inflation is durably reduced.

GDP growth increased to 0.4% in the third quarter of 2024 from 0.2% in the second quarter. Recent indicators suggest ongoing weakness of the economy, with the composite PMI at a level consistent with mild output declines in November. Headline inflation continued to moderate despite an uptick to 2% in October from 1.7% in September. Core inflation stood at 2.7%, unchanged from September, while market-based inflation expectations remain stable at the 2% target from 2025 onwards. However, underlying inflation pressures remain elevated, with services prices rising by 4% in annual terms. At the same time, the labour market remains tight with labour shortages particularly pressing in administrative and support services as well as construction. Strong growth in negotiated nominal wages is continuing, at 5.4% in the third quarter, up from 3.5% in the second quarter. The euro area seasonally adjusted unemployment rate stood at a post-pandemic low of 6.3% in September. Financial conditions eased further and the demand of firms for loans increased, alongside a strong rebound in housing loans and other lending to households. The number of bankruptcies rose to a new high in the first half of 2024, most significantly in construction and financial activities.

A smaller deficit in energy products and improving economic activity abroad supported a surplus in trade in goods in September. At the same time, merchandise trade continued to be affected by restrictive financial conditions, trade frictions and elevated geopolitical tensions. However, the fallout in the euro area from Russia’s war of aggression against Ukraine has moderated. 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. In support of Ukraine, EU countries have accorded temporary protection to more than 4 million Ukrainian refugees until March 2026. The EU has started to disburse EUR 50 billion (0.5% of euro area GDP) from the Ukraine Facility and approved an additional loan of up to EUR 35 billion (0.4% of euro area GDP), financed by proceeds from frozen Russian assets.

The aggregate euro area fiscal stance is projected to remain restrictive in 2024, and to a lesser extent in 2025 and 2026, with cumulative tightening of less than 1½% of GDP during these three years. The discretionary fiscal measures in response to the energy crisis and high inflation are projected to be gradually withdrawn by 2026. The ECB estimates that this fiscal support will amount to 0.4% of GDP in 2024 and 0.1% of GDP in both 2025 and 2026. The war in Ukraine has triggered additional military spending and the Next Generation EU (NGEU) programme is supporting public investments amounting to about 0.5% of euro area GDP per year. Given labour shortages in many countries, this spending needs to be carefully prioritised to ensure effective delivery.

The ECB has started reducing the restrictiveness of its policy stance, by cutting the deposit facility rate by a cumulative 75 basis points since June 2024. The policy rate is projected to decrease further, reaching 3% by end-2024 and, in consecutive cuts, 2% at the end of 2025. While the interest rate cuts will support aggregate demand, the overall stance of policy is projected to remain restrictive for some time to durably reduce underlying inflation pressures. The short-term inflationary effects stem from labour shortages as well as additional public expenditure associated with the NGEU programme, estimated to reach 2.5% of GDP by end-2026.

Growth is projected to improve, supported by easing financial conditions and benign energy and commodity prices. The labour market will remain tight, with labour shortages in many occupations and historically low unemployment slowing down wage growth normalisation. Growing real disposable incomes will support consumption, as disinflation continues. Private investment will be supported by the ongoing relaxation of financing conditions and public investment spending under the NGEU programme. Headline inflation is projected to moderate further, as labour cost pressures gradually dissipate. Core inflation is similarly projected to decline, returning to the level consistent with the ECB inflation target by the end of 2025.

The risks to the projections are tilted to the downside. Worsening geopolitical tensions, such as an escalation of conflict in the Middle East, would weigh on external demand. Higher transport costs resulting from Red Sea shipping disruptions could add to inflationary pressures. Financial stability risks are re-emerging in the euro area, with the number of bankruptcies historically high and remaining financial vulnerabilities in the commercial real estate and non-banking financial sectors. On the upside, a stronger use of accumulated household savings could strengthen private consumption. In addition, a durable reduction of geopolitical uncertainty could hasten disinflation and, together with stronger fiscal support in China, help lift external demand.

The investment needs associated with energy security and decarbonisation are considerable. At the same time, prudent fiscal policy needs to rebuild fiscal buffers in preparation for future shocks. Effective disbursement of the NGEU funds will help expand medium-term productive capacity but 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 need to be accompanied by effective guidance on how to reduce 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, with macroprudential policies and targeted instruments used to address potential vulnerabilities in the financial sector. Furthermore, labour shortages could be alleviated by attracting high-skilled non-EU workers and by reducing regulatory and administrative burdens on intra-EU labour mobility.