Real GDP is projected to grow by 1.2% in 2024, 2.3% in 2025 and 2.4% in 2026. Private consumption will remain robust as households’ real disposable income will be bolstered by a further round of wage indexation and receding inflation. Lower interest rates will help the financial and construction sectors to gradually recover. A faster than expected recovery in these sectors represents the main upside risk, while lower export demand due to weaker-than-expected economic activity in the euro area in 2025 and 2026 represents the main downside risk.

The fiscal stance will continue to gradually tighten over 2025-26. The headline budget balance will remain slightly negative in 2025 and 2026, but the deficit will gradually narrow. The fiscal stance seems broadly appropriate, but energy price ceilings should be removed as prices have moderated and household incomes have been supported by wage indexation. A comprehensive reform of the pensions system is needed to ensure long-run sustainability of the public finances. Addressing skills shortages by strengthening quality standards for training providers and raising the attractiveness of Luxembourg for foreign workers is key to promote sustainable growth in the long term.

Industrial production and construction activity have remained subdued in the first half of 2024 and business sentiment has struggled to improve. However, both transactions and prices in the housing market seem to have bottomed out. Lower interest rates have spurred the demand for mortgages and have fuelled a modest rebound in the financial sector. The number of unfilled job vacancies has come down from its peak in 2022 but remains higher than before the pandemic despite a relatively high unemployment rate. The wage indexation mechanism has prevented real wages from falling, safeguarding households’ purchasing power and supporting private consumption despite weak consumer sentiment. Both headline and core inflation have continued to fall, with annual headline inflation reaching 0.9% in October. Core inflation has been stickier, remaining at 1.9% in October, and this is mainly due to services inflation, which stood at 2.9% in October.

Net exports have grown in the first half of 2024, sustaining the recovery. The current account has improved, mainly due to higher exports of financial services, while goods exports have stabilised. The increase in unit labour costs relative to other EU countries since early 2022 represents a risk for international competitiveness.

The fiscal balance has declined in 2024, mainly reflecting lower revenues due to tax relief for businesses to compensate for past rounds of wage indexation and the adjustment of tax brackets to account for past inflation. In 2025, the fiscal stance will be broadly neutral, as the scaling back of energy support will be offset by higher public investment, tax measures for households and a corporate income tax cut. In 2026 the fiscal stance is expected to become slightly restrictive, as energy policy support is completely phased out.

Growth is projected to gradually strengthen over 2025 and stabilise in 2026. The easing of financial conditions will sustain the financial sector and help the construction sector to slowly recover. Private consumption will remain robust as disposable real income is going to be bolstered by a further round of wage indexation in 2025. The unemployment rate should peak around 6% in 2025 before gradually starting to decrease as activity picks up. Core and headline inflation are projected to continue to decline and reach 1.9% towards the end of 2026, although headline inflation is expected to pick up modestly in 2025 as energy price support is scaled back. Import growth is projected to strengthen in 2025, mainly due to a projected increase in machinery investment. This will reduce the contribution of net exports to GDP growth, but lower interest rates are projected to continue to foster exports of financial services, bolstering net exports in 2026. Risks are broadly balanced, with a faster than-expected recovery in finance and construction representing the main upside risk, while a slowdown of economic activity in the euro area in 2025 and 2026 may reduce growth by weakening exports.

The broadly neutral fiscal stance appears appropriate as the economy gradually recovers and the debt-to-GDP ratio remains low. However, energy policy support should be fully unwound as energy prices have moderated and household incomes have been supported by wage indexation. The key fiscal priority is to put the pension system on a sustainable footing, as pension expenditure is expected to sharply increase over the next few decades. Luxembourg further needs to implement structural reforms to transition to a growth model based on innovation and productivity growth. To tackle skills shortages and raise productivity, strengthening quality standards for training providers will be essential. Promoting the use of public transport and alternative sustainable commuting options by increasing capacity and expanding the network will lower emissions and raise the attractiveness of Luxembourg for cross-border workers.