Eurozone at a Turning Point: Cuts Begin, but Can Growth Hold?

Executive Summary

The Eurozone enters Q2 2025 in a delicate position: inflation is cooling, rate cuts are back on the table, and the consumer sector is holding firm. But underneath, growth is unbalanced, Germany’s industrial slowdown is deepening, and U.S.-EU trade tensions loom large. The ECB is preparing to act, but the room for policy error is narrowing.

GDP Outlook: Fragile Growth Driven by Services

Real GDP growth for 2025 is now projected at 0.9%, a downgrade from 1.2% earlier in the year. While consumer services and tourism are providing some lift, weak exports and declining industrial output, especially in Germany, are weighing on the broader recovery.

• Germany is on track for just 0.2% growth as factory orders and exports fall.

• France and Italy are expected to grow 0.8% and 0.6%, respectively, both restrained by fiscal and private sector investment challenges.

• Spain, by contrast, continues to outperform, with 1.5% projected growth fueled by tourism and domestic demand.

Scenario Analysis: Three Paths for the Economy

A persistent wildcard in the outlook is U.S. trade policy. The 90-day pause on new tariffs gives temporary relief, but renewed escalation, particularly on EU autos, would dramatically shift the growth picture.

Even under the base case, momentum is fragile, with limited cushion to absorb additional shocks.

Inflation: Cooling Headline, Sticky Core

Headline inflation fell to 2.2% in March, continuing its descent from last year’s highs. Energy prices have stabilized, and food inflation has moderated. But core inflation, currently at 2.5%, remains above target, largely due to sticky service-sector wage growth.

This mix gives the ECB cover to begin easing, but it also suggests a cautious approach ahead. Market expectations have priced in three cuts in 2025, beginning in April.

Monetary Policy: The Pivot Has Begun

The ECB is widely expected to cut the deposit facility rate by 25 basis points to 2.25% this month, marking its first rate cut since the tightening cycle began. With inflation trends easing and growth momentum slowing, policymakers are shifting toward support mode.

However, divisions remain within the Governing Council:

• Doves want to front-load cuts to preempt deeper weakness.

• Hawks warn of residual inflation risk, especially in services.

Expect future moves to be highly data-dependent, with trade policy developments also influencing the pace.

Divergence Across the Eurozone

Recovery is uneven across the bloc. Countries with strong domestic sectors (like Spain) are leading, while export-heavy and industrial economies (like Germany) are faltering.

This divergence complicates monetary policy calibration and points to asymmetric vulnerabilities across the zone.

Trade Tensions: A Critical Risk Factor

The U.S. has already reinstated some tariffs on EU aluminum and machine tools, and a broader tariff package targeting autos and consumer goods is still on the table. A re-escalation could:

• Shave off 1pp or more from Eurozone GDP

• Significantly hit Germany’s automotive sector

• Weaken EUR/USD further (already near 1.06)

With global supply chains still normalizing, renewed trade frictions would compound existing economic stress points.

Labor Market: Holding Up, But Productivity in Focus

Despite soft GDP prints, the labor market remains surprisingly firm:

• Unemployment is stable at 6.3%

• Wage growth in services is running at ~3.8%, above inflation

The ECB is watching this closely. If wages continue to rise faster than productivity, it could reignite inflation pressure or lead to margin compression for businesses, especially in southern Europe.

Outlook: What’s Ahead for the Eurozone in 2025

The Eurozone is likely to experience a mild, fragile recovery through 2025 driven by services, consumer resilience, and supportive monetary policy. But structural weaknesses and external shocks could easily tip the balance.

Macro Forecast Summary

Risks to Watch:

• Tariff escalation: Main downside risk for Germany and industrial sectors.

• Wage-inflation loop: Particularly in France and southern Europe.

• Energy/geopolitical shocks: Still capable of re-igniting inflation.

Final Takeaway: Strategy in a Narrowing Window

The Eurozone has entered 2025 with some relief — inflation is falling, and the ECB is ready to ease, but little room for error.

The Outlook makes it clear: soft landing is possible, but precarious. Services are doing the heavy lifting while industrial and external demand sag. With risks tilted to the downside, both policymakers and investors must remain nimble.

Strategic Implications:

• Investors should overweight domestic consumption plays (Spain, services) and underweight trade-exposed sectors (German autos, industrials).

• Monetary policy must stay flexible, with easing bias but vigilance on wages.

• Governments, especially in France and Italy, need structural reform to boost productivity and fiscal credibility.

Bottom line: The second half of 2025 will define whether the Eurozone can tiptoe into stable growth or slide back into stagnation. Patience, discipline, and data-driven decisions will be critical.