Europe’s economy faces a bumpy ride in 2025. Here are 5 things to watch

Between political upheaval, some weak economic data and warnings about falling short of its growth potential, Europe’s had a tough year. Amid a downbeat outlook, however, analysts say there could be some bright spots to watch for in 2025.

Economic growth in Europe isn’t expected to charge ahead any time soon, with the European Central Bank last week cutting its growth forecast for 2025 to 1.1%. ECB President Christine Lagarde, meanwhile, said risks to growth “remain tilted to the downside.”

It comes as GDP is expected to expand by 0.8% in the euro area this year — that’s an improvement from 2023’s annual growth rate of 0.4%, but a far cry from 2022’s 3.4%. In comparison, U.S. officials expect 2.7% growth this year.

Euro zone inflation is also in focus after sinking briefly below the ECB’s target in the autumn to 1.8%, but rising back above the 2% goal in November.

As investors and economists attempt to decipher what’s next for the region, here are five key things they’re watching as they weigh Europe’s prospects for 2025.

Policymakers at the European Central Bank announced their fourth and final rate cut of the year last Thursday. Markets are pricing in another 25-basis-points cut when the ECB’s Governing Council makes its first policy decision of 2025, according to overnight index swap data.

For Kallum Pickering, chief economist at investment bank Peel Hunt, that isn’t going far enough.

“Economic logic argues for 50-basis-points moves, [but] I don’t think they’ll go for 50 basis points,” he told CNBC’s “Street Signs Europe.”

“I find the ECB’s tone much too hawkish,” Pickering added, explaining that Europe’s economic issues had shifted from supply shocks to demand-side problems — making it doubtful inflation would still be “sticky” in six months’ time.

Index swap data suggests that, like Pickering, the majority of traders are expecting the ECB’s key rate — currently at 3% — to be reduced to 2% by mid-2025, with some anticipating further cuts in the second half of the year.

In a note to clients at the end of November, analysts at Bank of America declared 2025 “the year the [ECB’s] policy rate goes below 2%.”

“A [deposit facility] rate of 1% is easily thinkable,” they added.

A cautious consumer is among the many headwinds Europe has faced this year.

In a flash estimate for November, the European Commission found consumer confidence fell 1.2 percentage points year-on-year in the euro zone. Meanwhile, the European Commission’s economic sentiment indicator — a confidence score derived from business and consumer surveys — while stable, has remained below its long-term average all year, and is currently slightly lower than where it ended 2023.

However, Sylvain Broyer, chief EMEA economist at S&P Global Ratings, told CNBC that monetary policy changes in Europe could help boost lagging confidence levels.

“We think the ECB is in a position to accelerate rate cuts, which could help [growth] because confidence is still low despite the ongoing economic recovery,” Broyer — who is a member of the ECB’s “shadow council” of economists — told CNBC’s “Squawk Box Europe” last week.

“Fiscal policy has been restrictive over the past two years, if you add the restrictive monetary policy, the two legs of the policy mix in Europe have been restrictive — if we change that a little for 2025 that could help definitively.”

Chris Watling, CEO and chief market strategist at Longview Economics, highlighted a divergence among European economies, with a handful of European countries set to see their economic fortunes turn around.

“On a two-to-three-year view, Europe’s going to have some good times,” Watling told CNBC’s “Squawk Box Europe” earlier this month. “I think Southern Europe’s really exciting — it’s return of the PIIGS.”

The acronym PIIGS refers to Portugal, Italy, Ireland, Greece, and Spain, each of which has historically been considered vulnerable to economic instability and crises.

The European Commission expects the country’s GDP to expand by 3% this year and 2.3% in 2025, while the OECD expects Spain to see the third-strongest growth of all OECD nations this year. Greek economic growth, meanwhile, is expected to come in at 2.1% in 2024 and 2.3% in 2025.

Watling’s optimism about these countries comes despite a warning that Europe’s financial markets could “struggle” in the first six months of 2025, however.

“The great thing about having a crack in markets in the first half is that it encourages central banks around the world to cut rates more and gives us that reacceleration of the global economy in the back end of next year into 2026,” he said.

Although some good news may be on the horizon for Europe, a second Trump presidency — and the tariffs that could come with it — has the potential to create fresh obstacles.

President-elect Donald Trump’s threats to impose 10% to 20% tariffs on all U.S. imports has sparked uncertainty across European firms and led to questions about how the region could respond.

In its European Road Ahead report, Citi said a 10% tariff could lower EU GDP by 0.3% by 2026, “while a new U.S.-China trade war could double the damage in exposed countries like Germany.”

“We think like-for-like retaliation unlikely, which would make this a deflationary shock, but global fragmentation will hurt trade-dependent Europe in the long run,” the analysts added.

Janet Mui, head of market analysis at wealth manager RBC Brewin Dolphin, said tariffs were likely being used as a bargaining chip by the incoming U.S. administration.

“Tariff is a key threat of course. But it’s probably a reasonable assumption that Trump doesn’t go all the way with his threats,” she added.

Europe is also facing political uncertainty inside its borders, with two of the region’s biggest economies, France and Germany, in the throes of political turmoil.

Former French Prime Minister Michel Barnier was ousted and replaced earlier this month, while German Chancellor Olaf Scholz lost a confidence vote on Monday, paving the way for elections early next year.

“Think of [Europe] as a soufflé, and the rising part of the soufflé was always France and Germany, and that has really collapsed into stagnation and paralysis,” David Roche, a strategist at Quantum Strategy, told CNBC earlier this month.

“The core of Europe [looks] incredibly bad economically and politically, and I think markets will eventually reflect that.”

Maximilian Uleer, head of European equity and cross-asset strategy at Deutsche Bank, said political uncertainty in Germany could in fact spark a turnaround in the country’s faltering economy, however.

“Germany is known for its political stability — there were only two instances of a coalition break-up in recent history,” he said in a Dec. 16 note to clients. “Both times, Germany was facing a recession, introduced reforms and re-emerged stronger … Don’t underestimate Germany’s capacity to change.”