The euro area is forecast to avoid recession despite Trump tariffs

The 2025 outlook for the euro area economy is forecast to be challenging amid trade uncertainties with the US and ongoing fiscal tightening. But the region is predicted to avoid recession, even as Goldman Sachs Research projects GDP growth to lag behind expectations.

The euro area economy is predicted to expand 0.8% in 2025, compared with the consensus forecast of economists surveyed by Bloomberg indicating 1.2% growth. German GDP is expected to contract 0.3% and France's economy will shrink by 0.7%, while Spain's GDP (again outperforming) will increase by 2%, according to Chief European Economist Sven Jari Stehn.

US President-elect Donald Trump's planned tariffs are likely to weigh significantly on growth, with much of the drag stemming from higher trade policy uncertainty, Stehn writes in the team's report, which is titled "Euro Area Outlook 2025: Under Pressure." Although the region's economy is expected to expand in the coming year, there's a 30% chance of a significant recession.

How will tariffs impact the euro area economy?

While the size of any US tariffs is highly uncertain, Goldman Sachs Research finds that much of the drag to growth will come from higher trade policy uncertainty, rather than the actual tariff increases themselves. "Trade policy uncertainty measures have already been on the rise," Stehn writes.

Goldman Sachs Research's baseline expectation is for the Trump administration to impose targeted tariffs on Europe, focusing on auto-related exports. Elevated trade tensions are projected to lower the level of area-wide real GDP by 0.5%. The hit is likely to be largest in Germany (0.6%) and smallest in Spain and Italy (0.3%), given differences in trade openness and manufacturing intensity. Our economists' estimates suggest the hit to GDP would be twice as large in a scenario where the US imposes a 10% across-the-board tariff on the EU.

Europe's manufacturing sector also faces structural headwinds. Energy prices have fallen markedly from their peak, but European gas prices remain notably above pre-2022 levels and are materially higher than in the US. China has emerged as a key competitor to European goods production, gaining material market share in industries that have seen cost increases.

"We see a continued structural headwind to the industrial recovery next year, particularly in Germany," Stehn writes.

Why the euro area is projected to avoid recession

At the same time, the euro area is also expected to undergo fiscal tightening next year. Germany's "debt brake" will contain its scope for spending, while France aims to rein in its budget. The European Recovery Fund is expected to provide fiscal support in 2025, but the boost isn't likely to be enough to fully compensate for the contraction in fiscal policy at the national level.

Despite those challenges, economic activity data for the euro area indicates modest but positive growth. Real (inflation adjusted) income is predicted to increase and savings are elevated, both of which are anticipated to support household spending. The economies in southern Europe are expected to be more resilient than those in the north.

"We look for growth moderation across the South next year, but we see greater resilience to trade tensions and competitive pressures from China than in the North," Stehn writes. GDP growth in those countries has been underpinned by the services sector, elevated immigration, and investment from the Recovery and Resilience Facility.

Slow GDP growth will likely result in a softer job market next year. The unemployment rate, at 6.3% in September, is forecast to rise next year and to reach 6.7% by early 2026. Wage growth is projected to slow. "A softening labour market supports our view of cooling wage growth," Stehn writes. "Following notable upside surprises early in the year, pay pressures have now cooled meaningfully."

Inflation is forecast to fall to 2% in 2025

Inflation has been declining since the summer, and headline and core inflation are projected to return to a sustainable 2% rate by the end of next year as services inflation cools.

"The outlook for inflation, however, remains notably uncertain," Stehn writes. Depreciation in the euro could indicate stickier-than-expected inflation pressures. On the other hand, inflation could be more subdued amid a weakening job market and in the event of higher-than-expected US tariffs on China, which could incentivise China to sell excess goods at reduced prices into Europe.

Slow economic growth and declining inflation will likely pressure the European Central Bank to cut interest rates. Goldman Sachs Research expects the Governing Council to cut the deposit rate to 1.75% in July (from 3.25% in October). While 25 basis point cuts are more likely than 50 basis point reductions, there's a "a low hurdle for a step-up in the pace in Q1 if the growth and inflation data disappoint notably," Stehn writes.

Former ECB head Mario Draghi has identified policies that could help boost productivity and GDP expansion in Europe, but there are significant hurdles for implementation, particularly when it comes to joint EU funding. "However, we see scope for additional EU defence spending and some regulatory harmonisation from next year," Stehn writes.

This article is being provided for educational purposes only. The information contained in this article does not constitute a recommendation from any Goldman Sachs entity to the recipient, and Goldman Sachs is not providing any financial, economic, legal, investment, accounting, or tax advice through this article or to its recipient. Neither Goldman Sachs nor any of its affiliates makes any representation or warranty, express or implied, as to the accuracy or completeness of the statements or any information contained in this article and any liability therefore (including in respect of direct, indirect, or consequential loss or damage) is expressly disclaimed.