Introduction
The European economy is caught in the currents of deep global transformation. The international economic order that has been shaped over the last decades is increasingly coming under fire. Established rules are no longer regarded as binding and new principles have yet to take their place. Particularly the latest protectionist measures of the United States, introduced in phases since the beginning of the year and now affecting large swathes of global trade, mark a paradigm shift. With an almost universal increase in tariffs, the tariff policy of the United States has reached a magnitude that surpasses even that of the Great Depression and is tangibly weighing down the global economy. Even if a temporary pause of certain tariff measures has been agreed in the meantime, the standard procedure is to take into account that these measures will come into force again.
In parallel, fiscal policy in Europe and especially in Germany is changing tack, with a substantial rise in public investment, particularly in the areas of infrastructure and defence. The resulting momentum should prop up domestic demand in the medium term. However, it will take time before public investment packages are implemented and take effect, with the impact on the economy not expected to show before 2026
Following the relatively weak growth seen in 2024, economic momentum in Europe could have picked up this year given the clear recent uptrend in real incomes and the robust state of the labour market. However, the increasing protectionist pressure coming from the United States has considerably dampened the economic prospects of export-oriented member states, in particular. The upturn is therefore set to remain fragile and weak and rely largely on the resilience of domestic demand and monetary policy stimulus
Our growth outlook presents a compact overview of the key macroeconomic developments in the euro area, examines the main economic drivers and risks, and puts the role of fiscal and trade policy drivers into a European context with the objective of providing decision-makers in politics, business and society a solid basis for strategic assessments and economic policy decisions.
Growth in the euro area
Moderate growth in the euro area in 2024, robust first quarter 2025
In 2024, real growth in the euro area amounted to 0.9 percent. Following a relatively weak start to the year, with weak investment and shrinking inventories keeping growth down to only 0.5 percent year on year in the first two quarters, the pace of growth picked up to one percent in the third quarter and 1.2 percent in the fourth quarter 2024. Private and public consumption were the main drivers of growth in the second half of the year. Net exports, on the other hand, failed to contribute tangibly to growth and even pulled growth down slightly in the fourth quarter 2024, while gross fixed capital formation also continued to tug down growth (negative contribution of minus 0.3 and 0.5 percentage points respectively).
For the first quarter 2025, preliminary estimates put growth in the euro area at 1.2 percent year on year. Quarter on quarter, growth was 0.4 percent. Among the member states for whom first quarter 2025 figures were already available, Ireland recorded the strongest year on year growth at 10.9 percent, followed by Lithuania at 3.2 percent and Spain at 2.8 percent. Germany recorded growth of minus 0.2 percent (but up 0.2 percent quarter on quarter), France 0.8 percent and Italy 0.6 percent.
The country with the lowest growth was Hungary at minus 0.4 percent. The sparse country-specific figures available indicate that domestic demand remained resilient, possibly propped up by a degree of frontloading ahead of higher tariffs. It should be remembered, however, that growth in the euro area was largely the result of strong growth in Ireland, which has, in the past, frequently been subsequently revised (UBS, 2025).
Private Consumption
Changes in inventories
Net exports
Public Consumption Gross Fixed Capital Formation Total
*Change over previous year, calendar and sesonally adjusted
Sources: Macrobond, Eurostat
Industrial production, downward for 21 months straight according to the less volatile two-month comparison (since May 2023) and dogged particularly by the persistently high energy prices on an international comparison, experienced a ray of light in February 2025 with production nudging up 0.2 percent compared to the previous month. Yet, it remains to be seen whether this was just a blip.
*Change over previous year, 2-month-average, Volume index, seasonally adjusted)
Sources: Macrobond, Eurostat
The low capacity utilisation rates across the euro area also point to continued subdued industrial activity. Capacity utilisation has been on a downward trend since early 2022, signalising that many companies are not using their production facilities to full capacity. This is a reflection of both weak
Growth outlook marked by US trade conflict and realignment of public spending
The current growth outlook for the euro area is largely marked by two developments. The first is the imposition of new US import tariffs and possible European retaliatory measures, the second, the new alignment of public spending in Europe, centring on defence and infrastructure. Both factors will have a major impact on the economic momentum in the euro area and are therefore analysed in depth in the section on macroeconomic parameters and only briefly outlined below.
The tariff measures announced or already implemented by the United States are set to curb growth tangibly across the strongly export-oriented euro area. Retaliatory tariffs, if imposed, could well exacerbate the negative impact on trade. Nor can these upheavals be cushioned by any revenue from retaliatory tariffs or from passing this on to consumers and companies. The uncertainties caused by the abrupt and unpredictable tariff policy of the United States will already impact investment and international supply chains in the short term. Alongside the direct effects of US tariffs on European products and the uncertainties this causes, it can be expected that the decrease in demand from key third countries, above all the strongly affected Asian region, will exacerbate international competition and put downward pressure on prices, thus further curbing growth. Additionally compounding the situation, the appreciation of the euro against the US dollar (up ten percent between 2 January and 5 May) following the tariff shock has further impaired the competitiveness of European exporters.
On the other hand, Europe is experiencing a change in course in fiscal policy. Many member states, particularly Germany, are currently substantially increasing their public spending. The focus of this increased spending is investments in defence and infrastructure, which should prop up overall economic demand. However, the fiscal policy space of many European countries is very limited. Furthermore, higher spending packages will take some time to implement and are not expected to unfold their full impact before the medium term, in the next three to four quarters, which carries us into 2026. The negative impact of tariffs and political uncertainties will thus almost certainly dominate the picture in the short term
PMIs take a slide with steeply increased political uncertainties
The preliminary HCOB Purchasing Managers’ Index for the euro area compiled by S&P Global (2025) was watched particularly closely in April, the first month since the introduction of the new tariffs. The Composite PMI dropped 0.8 points down to 50.1, signalising only weak growth in the second quarter this year. The manufacturing sector remained surprisingly resilient. The Manufacturing PMI nudged up 0.1 points to 48.7 points, instead of the anticipated downward movement. Exports remained robust despite the new tariffs, possibly also due to purchases being pulled forward (DB Research 2025). This is also indicated by the estimates of US growth in the first quarter, which show US imports surging up at an annualised rate of 41.3 percent (BEA 2025). The decrease in energy prices is also likely to have played a role in propping up producer confidence. The service sector was much weaker. The Services PMI dropped 1.3 points down to 49.7, also below the threshold to expansion of 50 points. Germany and France are followed a similar pattern on a national level, with industry outperforming expectations and services under pressure.
The real effects of the tariffs could nonetheless play out a little further down the line and then weaken the confidence of producers, in particular. According to DB Research (2025), the risk of recession and economic uncertainty are increasingly tangibly, triggered principally by growing trade risks and less favourable financing conditions. The probability of recession this summer has increased from about
With trade barriers set to increase considerably, weakening business and consumer confidence, slightly more stringent financing conditions and the delayed impact of fiscal measures, we now only expect the euro area to grow by 0.8 percent in 2025 overall. In our Global Growth Outlook at the start of the year, we had forecast growth of one percent Positive factors for the economy in the euro area are continuing investment under the EU fund NextGenerationEU, resilient labour markets and the anticipated further monetary easing by the ECB.
Germany
In view of the escalating tariff dispute between the United States and the rest of the world, Germany’s gross domestic product is likely to decrease somewhat more than the 0.1 percent forecast by us in January. The negative impact of the US tariff increases could amount to between 0.3 and 0.4 percent. We expect fiscal policy, on the other hand, to contribute slight upward momentum of between 0.2 and 0.3 percentage points of GDP (ten to twelve billion euros, of which eight to nine billion euros result from the announced immediate depreciation programme). We therefore currently expect Germany’s GDP to drop by around 0.2 percent this year. The result may be a little more positive (possibly low positive growth) if the announced reliefs set out in the federal government’s immediate action plan are implemented as soon as the new government takes office (immediate depreciation retroactively until 2025, reduction of energy costs by reducing electricity tax and grid fees, abolishment of the gas storage levy, introduction of an industrial electricity price, reduction of bureaucracy).
Reasons for the low underlying growth are the persistent consumption reticence of consumers (on account of uncertainty and despite the recent solid rises in real incomes), low momentum for growth from investment in plant and equipment (low capacity utilisation) and in construction (construction costs, interest rates). Although we do expect expenditure on infrastructure and defence to increase, the increase here will not be sufficient to compensate for the drops in foreign trade this year. The fact that the new US tariff rates are on an unprecedented level means that it is not possible to reliably quantify the impact they will have on German exports. Most model calculations expect exports to the United States to decrease by between 15 and 20 billion euros, which corresponds to a drop in overall exports of between one and 1.3 percent. This is on a similar scale to the decrease already expected by us in German exports of half a percent, bringing the overall drop here to between 1.5 and 1.8 percent.
Regarding industrial production, we expect the downtrend in Germany to continue in 2025. Our forecast so far of minus 0.5 percent has considerable downside risks in view of US tariff policy and a possible global escalation of the trade conflict. The course of industrial production throughout the year (from January to December) is also likely to be correspondingly weaker on account of the tariff issues.
France
The French economy recorded growth of 1.2 percent in 2024, exceeding expectations which were subdued particularly on account of the increased political uncertainty in the country. Growth was driven principally by robust private consumption and strong net exports, which both contributed 0.9 percentage points to GDP growth Towards the end of the year, momentum tailed off slightly, particularly after the temporary normalisation following the economic stimulus of the summer Olympics in Paris. At the same time, corporate investment activity and residential construction also lost steam (Banque de France 2025; IMF 2025).
At the start of 2025, in the first quarter, the economy continued to grow moderately with gross domestic product rising 0.8 percent year on year (annualised) but only 0.1 percent quarter on quarter (quarterly rate). For 2025 overall, growth is likely to remain positive but be lower than in 2024. Overall, we expect France to grow by 0.6 percent in 2025.
The Banque de France (2025) most recently forecast growth of 0.7 percent in 2025, a downward adjustment of 0.2 percentage points compared to its forecast of December 2024, and higher growth of 1.2 percent for 2026. While the fiscal consolidation path announced in autumn 2024 will probably be somewhat weaker than originally presumed by the Banque de France, the consequent positive impact on growth is likely to be largely cancelled out by increasing global uncertainty and the wait-and-see attitude adopted by domestic economic actors.
It is important to emphasise that the Banque de France’s forecast only partially takes account of the potential economic impact of the most recent trade policy measures of the United States. The influence of overall uncertainty on the French economy has already been factored into the forecast and is set to reduce growth by around 0.1 percentage points in 2025. Overall, the Banque de France concludes that the impact of the US tariffs on France will be qualitatively similar but quantitatively less than on the EU and the euro area as a whole. The reason for this is the relatively low exposure of France to the US market. Exports to the United States only account for 1.7 percent of French GDP, which is around 40 percent less than the EU average (2.8 percent of EU GDP). Interestingly, the survey data up to March does not indicate any frontloading ahead of the tariffs (DB Research 2025b).
The forecast published by the International Monetary Fund (IMF) around one month later is slightly lower than the Banque de France forecast. The IMF expects France to grow by 0.6 percent in 2025, which is plausible given the lower momentum recorded in the first quarter, the slowdown in late 2024 and the planned fiscal consolidation Although downside risks still dominate the outlook, there is some upside potential at the end of the forecasting period, particularly if military expenditure rises.
Italy
The Italian economy grew by 0.7 percent in 2024. Growth was fuelled primarily by public investment under the country’s Recovery and Resilience Plan (NRRP) which was able to partially compensate for the contraction in residential construction following the termination of tax incentives for renovation works (European Commission 2024).
At the start of 2025, the Italian economy was still relatively stable. In the first quarter, gross domestic product (GDP) was 0.3 percent higher than the previous quarter and 0.6 percent higher than the same quarter last year. The IMF forecasts moderate growth of 0.4 percent in 2025 overall and accelerated growth of 0.8 percent in 2026. The Italian industry association Confindustria (2025) blames the lower growth this year principally on US trade tariffs and the associated global uncertainties that are weighing down investment and consumption.
Positive factors identified by Confindustria are the lower energy prices and the continuing robust state of the labour market. Despite the economic slowdown, employment levels in the first quarter 2025 were one percent up on the fourth quarter 2024, which corresponds to over 230,000 more jobs.
Italy’s economic ties to the United States are considerable. The United States is the main destination country of Italian exports, services and direct investment outside of the EU. The United States receives
10.8 percent of Italian manufacturing exports. Confindustria highlights that direct and indirect sales to the United States account for around seven percent of Italian industrial production (around 90 billion euros). Pharmaceuticals, the automotive industry and machinery manufacturers are particularly affected. According to estimates, trade tariffs and uncertainties could reduce Italian GDP growth by 0.3 percent in 2025 and 2026, with weaker exports (down 1.2 percent) and lower investment in plant and machinery (down 0.4 percent).
Despite the stable labour market, business confidence is dropping, and investment decisions are increasingly being postponed. While the tourist sector recorded a strong start to the year, other service industries showed first signs of flagging, reflected in downward sentiment indicators and purchasing managers’ indices.
The prospects for the Italian economy therefore remain subdued in 2025. External trade tensions and internal challenges are stifling economic momentum. While the investment under the NRRP will continue to stabilise economic activity, the overall economic environment remains fragile and the downside risks substantial. For 2025 overall, we expect growth of 0.4 percent.
Spain
The Spanish economy recorded robust growth of 3.2 percent in 2024, which is well above the euro area average of 0.9 percent. This growth was fuelled by strong domestic demand, particularly with surprising positive results in investments and public spending. Net exports, on the other hand, made a negative contribution to growth (Banco de España, 2025).
The dynamic start to 2025 continued this positive trend. In the first quarter of the year, the Spanish economy grew by 2.8 percent year on year and 0.6 percent quarter on quarter. For 2025 overall, the IMF (April 2025) expects a slight slowdown in growth to a still solid level of 2.5 percent. The IMF has upwardly revised its forecast of January by 0.2 percentage points. The main reasons for the upward revision were the positive carryovers from the unexpectedly good performance in 2024 and the reconstruction measures following the catastrophic floods
The growth forecast of Spain’s central bank from March 2025 is slightly higher at 2.7 percent. Growth is being driven particularly by private consumption. State consumption is also set to make a positive but lower contribution to growth. Noteworthy is that state consumption in 2023 and 2024 constituted around 39 percent and 27 percent of GDP growth respectively. For the coming years, the contribution of state consumption is expected to be more moderate. Investments, on the other hand, are set to increase. Buoyed by funds from the EU programme NextGeneration and an improvement in financing conditions generally, despite the most recent tightening, investment activity is expected to rise modestly. Investment in residential construction is also expected to increase. Net exports, on the other hand, are likely to make a slightly negative contribution to growth. The export of services, which has registered steep increases in the last few years, is set to lose steam.
The labour market will remain robust. For 2025, employment is expected to increase by 1.9 percent and the number of hours worked to rise by 1.7 percent. The unemployment rate is forecast to drop from 11.3 percent in 2024 to 10.5 percent.
It is important to note that the projections of the Spanish central bank do not factor in negative effects caused by increased uncertainty, geopolitical tensions and possible US tariffs. However, Spain is also
relatively unexposed compared to other European countries. Some of the most important export categories, such as petroleum products, only have a domestic value added share of 17 percent. Overall, the indirect exposure of Spain to the US market through European trade amounts to 1.1 percent of GDP. A US tariff of 20 percent could have a negative impact on GDP of around 0.2 percentage points in the short term. The impact could increase in the long term as investment and new jobs also take a toll (ING 2025).
The official forecasts do not take account of these risks or of the possible positive momentum from higher defence expenditure in Spain and in the EU, which could additionally prop up growth in the next few years. On account of the strong start to the year, we expect Spain to grow by 2.6 percent this year.
Our forecast for the euro area and the four largest EU countries is summarised in the following overview
Our forecast for the euro area and the four largest EU countries is summarised in the following overview
Sources: Eurostat, Forecast: BDI and IMF (*). (p) = Preliminary (e) = Estimate
announces retaliatory tariffs of 25 percent on US goods worth 155 billion Canadian dollars. Tariffs with immediate effect on goods worth 30 billion Canadian dollars.
▪ 6 March 2025 – US exempts USMCA-compliant imports from Canada and Mexico and lowers tariffs for energy imports and potash to ten percent and, for goods that are not USMCA compliant, 25 percent tariffs are in place.
▪ 10 March 2025 – Chinese tariffs on US agricultural products take effect (15 percent on corn and ten percent on soybeans). In addition, China adds another 15 US companies to its export control list.
▪ 12 March 2025 – US tariffs of 25 percent on steel and aluminium go into effect. Canada and the EU announce retaliatory tariffs.
▪ 26 March 2025 – Trump announces 25 percent global import tariffs on cars and automotive parts (cars: from 3 April; parts: from 3 May).
April 2025
▪ 2 April 2025 – Introduction of the Fair and Reciprocal Plan: baseline ten percent tariff on virtually all countries starting 5 April. Country-specific tariffs of up to 50 percent for around 60 countries (from 9 April). US also announces end of duty-free treatment of goods worth less than 800 US dollars from China and Hongkong from 2 May.
▪ 3 April 2025 – US tariffs of 25 percent on cars take effect but not parts. Canada announces 25 percent retaliatory tariffs on non-USMCA compliant vehicles.
▪ 4 April 2025 – China announces 34 percent retaliatory tariffs on US imports (effective as of 10 April) and additional export controls.
▪ 5 April 2025 – Ten percent US tariffs on virtually all countries take effect
▪ 8 April 2025 – US counter-retaliates with an additional 50 percent of tariffs on China in response to China’s retaliatory measures. This brings the total US tariff increase on imports from China associated with the original 2 April announcement to 84 percent (with sectoral carve-outs), in addition to the 20 percent (no sectoral carve-outs) of 4 February and 4 March.
▪ 9 April 2025 – Differentiated US tariffs (one to 74 percent) on countries that have a goods trade surplus (as announced on 2 April). The 25 percent Canadian retaliatory tariffs on US vehicles announced on 3 April take effect. The EU member states agree on retaliatory tariffs on the US for the US steel and aluminium tariffs of 12 March. Some tariffs will enter into force on 15 April, some on 15 May, and others in the autumn. China announces additional 50 percent tariffs in response to US tariffs announced on 8 April, so that its most recent combination of retaliatory tariffs match the new US additional tariffs of 84 percent. After the tariffs have taken effect, US President Trump declares that the differentiated tariffs on trade surplus countries announced on 2 April will be paused for 90 days. However, the 10 percent tariffs on nearly all countries remains in effect. Because it retaliated, China will now also face a higher tariff of 125 percent, and not the combined 84 percent of the 2 April and 8 April executive orders. In combination with the tariffs imposed under the International Emergency Economic Powers Act, most imports from China now have a higher combined tariff of 145 percent.
▪ 10 April 2025 – US and China tariff retaliation of 4 April and 9 April go into effect. The EU puts retaliatory measures announced on 9 April on hold for 90 days.
▪ 11 April 2025 – US: Smartphones and other electronics exempted from tariffs. China announces additional tariffs to match the total US additional tariffs of 125 percent.
▪ 12 April 2025 – Additional Chinese tariffs (now a total of 125 percent) go into effect (announced on 11 April).
▪ 29 April 2025 – The White House issues orders to cushion effect of automotive tariffs on US manufacturers. Automotive manufacturers can offset tariffs on imported parts in the amount of up to 3.75 percent of the suggested retail price of vehicles assembled in the United States until 30 April 2026 and, after that and until 30 April 2027, up to 2.5 percent of their US production.
▪ 8 May 2025 – The US and the UK sign a trade agreement with tariff reductions on cars, steel and agricultural products.
▪
12 May 2025 – The US and China agree on a 90-day tariff pause from 14 May with tariff reductions agreed on both sides (from 145 percent to 30 percent and from 125 percent to ten percent, respectively).
Economic theory leaves no room for doubt that tariffs curb growth, reduce efficiency and ultimately harm all parties involved. For countries imposing tariffs, it causes a negative supply shock. The tariffs make imports more expensive than domestic products, which, in theory, could serve to boost domestic production. The negative effects nonetheless prevail. Higher import prices reduce the purchasing power of consumers and burden businesses with higher costs for inputs. This stifles consumption and investment and can increase uncertainty regarding future conditions of trade. An overall appreciation of the currency, which is likely, can further exacerbate this effect as domestic products become more expensive abroad. This did not happen initially in the case of the United States. Unusually, the exchange rate of the US dollar and the prices of government bonds dropped while yields increased. This happened because international investors shied away from the United States out of increased uncertainty and fears of a recession.
Sources: Macrobond, European Central Bank
Countries targeted by tariffs experience a negative demand shock. Export-oriented economies will see exports to the affected markets decrease. Disrupted supply chains drive up the prices of imported inputs, which puts pressure on industrial production. The uncertainty of future trade relations leads to businesses holding back investment and consumers holding back spending and thus, ultimately, to lower domestic and foreign demand. Without fiscal and monetary response measures, tariffs have a substantial negative impact on growth, particularly in strongly export-oriented regions such as the euro area. Retaliatory tariffs further exacerbate the negative effects on growth.
The United States has said that it is following several objectives with its trade policy approach. It aims to bring back industrial jobs and combat unfair trade practices and reduce the country’s trade deficit (3 1 percent of US GDP in 2024, BEA 2025b). Furthermore, US trade policy is designed to reduce the US economy’s dependence on foreign producers. Alongside China, the EU trade surplus with the United States is a particularly painful thorn in the side of the US administration.
As shown in the following figure, the overall current account balance of the euro area has been positive for many years and was at close to 40 billion euros at the start of the year. For 2024 overall, the euro area recorded a current account surplus of 426 billion euros, which corresponds to 2.8 percent of GDP. For comparison: In the previous year, the surplus was at 243 billion euros or 1.7 percent of GDP (ECB 2025). The positive balance is primarily due to the surplus in the trade with goods, which at 325 billion euros in 2024 was more than double the surplus in services of 157 billion euros. While there was a primary income surplus in 2024 of 47 billion euros, there was a deficit of 161 million euros for secondary income
In a bilateral comparison between the EU overall and the United States, trade with goods and services in 2023, the most recent year for which the figures are complete, amounted to a total volume of around 1.6 trillion euros. The EU recorded a modest trade surplus of 48 billion euros, which only corresponds to three percent of total trade between the EU and the United States. This was the result of a clear surplus in the trade in goods. Goods exports from the EU to the US amounted to 503 billion euros while imports from the US amounted to 347 billion euros, which constitutes a surplus for the EU of 157 billion euros. This was partially offset by a deficit in the trade in services of 109 billion euros, with service exports of 319 billion euros and service imports of 427 billion euros. Not only does this show that the bilateral relationship is relatively balanced, but the high volumes of trading involved also underline the economic relevance of the transatlantic relations. Even low-level trade tensions and new tariff measures can already have a substantial impact on businesses on both sides of the Atlantic.
Furthermore, it is regarded as highly unlikely that the current trade policy approach of the United States will significantly change the external deficits as these are driven primarily by national levels of savings compared to investment, and notably fiscal policy measures, the particularly large budget deficits in the United States, low overall savings and high consumption. The tariffs that have already been imposed or only threatened are therefore not likely to improve the bilateral trade balances either. In addition, they considerably reduce trading profits, particularly in those areas in which these are the highest and thus reduce consumer welfare.
There are several models to calculate the impact of the US tariffs on the growth prospects of the euro area and the EU. The models use varying assumptions regarding the level of tariffs, the date of tariffs coming into effect, the elasticities and possible retaliatory measures and are therefore not directly comparable. In the following section, we present a selection of various studies:
▪ The German Economic Institute (IW), (2024) calculated last year that a transatlantic trade dispute with reciprocal tariffs of 20 percent could reduce EU GDP by 0.4 percent in 2025, 1.1 percent in 2026 and 1.3 percent in 2027 and 2028.
▪ The Kiel Institute for the World Economy (2025) estimates, based on its KITE model, that the new US tariffs announced in early April 2025 could reduce EU economic output by a good 0.2 percent within one year
Fiscal policy is likely to be slightly looser than assumed at the end of last year. Particularly the planned additional defence expenditure, above all Germany’s additional investment plans, and potential measures against the dampened economic prospects in the euro area on account of US tariff policy are likely to lead to increasing financing deficits. These expenditures are set to be largely financed initially by net borrowing, especially in some Nordic, Baltic and Eastern European countries and in Germany. Spain, long regarded within the NATO as lagging behind in its military spending with around 1.3 percent of GDP, recently announced that it would meet NATO’s two percent defence spending target already this year and not as originally planned in 2029 (Table Europe 2025).
In light of the above, the fiscal rules have already been partially adapted to accommodate an increased defence spending and infrastructure investment. On a national level, Germany has loosened borrowing restrictions for defence spending by making amendments to its constitution. Specifically, the modification of Germany’s debt brake means that all spending on defence and other security policy tasks1 over one percent of GDP will no longer be subject to limits. This enables borrowing for defence without limits both in terms of time and volume. In the wake of this modification, the debt brake was also amended at the federal state level to lift the upper limit for net borrowing from zero percent to 0.35 percent of GDP in line with the federal government. Furthermore, a special fund for additional investment in infrastructure has been set up to reach climate neutrality by 2045 with a volume of 500 billion euros over the next twelve years, of which 100 billion euros will go to the federal states and 100 billion euros will be transferred to the Climate and Transformation Fund (KTF). The coalition partners also intend to reform Germany’s fiscal rules. 1
Deficit and debt ratios in the euro area in 2024
Deficit in percent of GDP
Sources: Macrobond, European Commission (Ameco)
Sweden already abandoned its target of a two percent budget surplus last year and is now targeting a balanced budget from 2027 onwards to enable higher military spending and further public investments.
At European level, the European Commission (2025 and 2025b) presented its ReArm Europe Plan on 4 March 2025. The objective of this plan is to mobilise up to 800 billion euros to strengthen European defence capacities. The plan is based on three central pillars:
1. The coordinated activation of the national escape clause of the Stability and Growth Pact: The activation of the national escape clause will temporarily allow member states to make additional, loan-financed defence spending, up to around 1.5 percent of GDP above the 2021 level, without necessarily triggering an excessive deficit procedure. This clause allows for a deviation from the agreed expenditure path for a period of up to four years (extendable) in so far as the additional spending is used exclusively for defence purposes. The national escape clause is activated by the Council upon a recommendation by the Commission, following a request by the Member State. According to a Communication of the European Commission (2025c), the European Commission and the Council can decide not to initiate an excessive deficit procedure if the excessive deficit of over three percent of GDP or a deviation from the agreed expenditure path is due to increased defence spending. This is particularly relevant for member states with debt above 60 percent of GDP, as relevant factors can only be considered if the debt level is declining at a satisfactory rate. Apart from the additional leeway for defence expenditure, the EU fiscal rules will continue to operate normally. The decision on whether to open an excessive deficit procedure will also consider risks to fiscal sustainability. According to a press release by the Council of the European Union (2025) of 30 April, 16 EU member states have so far decided to apply for an activation of this clause.
2. The introduction of the Security Action for Europe (SAFE) instrument: The purpose of the new EU instrument SAFE is to raise up to 150 billion euros on the capital markets for additional defence spending. Financed by bonds backed up by the EU budget, member states can then receive long-maturity competitively priced loans with a maximum duration of up to 45 years and a 10-year grace period. The allocation of the funds will be demand-driven and not have an allocation key. Funds will be used to support joint defence projects and to strengthen the European defence industry. The European Union institutions have yet to decide on these issues. It remains to be seen whether and in what scope these funds will be drawn on
3. Contributions from the European Investment Bank (EIB): The EIB is to contribute purposefully to mobilising private capital by cofinancing or guaranteeing investments in security-relevant key technologies and infrastructure.
The planned additional spending for defence and infrastructure will lead to looser fiscal policy in the corresponding countries and support economic activity, counteracting the demand shock triggered by the tariffs The additional spending should have an anti-cyclical effect but will also increase the degree of fiscal adjustment needed in the medium term.
Higher defence spending can temporarily lift demand, employment and revenue, especially if financed by loans A longer-term effect can be potential growth gains through innovations. In advanced economies, the fiscal multipliers, particularly in times of recession, can be larger than one. The average value is estimated at around 0.8. That means that military spending does not necessarily suppress private demand (Sheremirov and Spirovska 2022). A study by Ilzetzki (2025) estimates that overall
deliver investments and reforms that respond to the main challenges identified in the context of the European Semester
The European Commission provides those member states with government debt of more than 60 percent of GDP or a government deficit of more than three percent of GDP with a reference path for the country’s multi-year net expenditure that is not publicly disclosed. This takes account of the country-specific challenges and ensures that public debt is reduced sustainably or stabilised at a solid level.
The new rules include two safeguards:
▪ The debt sustainability safeguard: a measure to safeguard debt sustainability by ensuring a minimum reduction of the government debt ratio. The debt ratio needs to decline by a minimum of at least one percentage point of GDP per year if debt exceeds 90 percent and 0.5 percentage points of GDP if the debt ratio ranges between 60 percent and 90 percent.
▪ The deficit resilience safeguard: creates a safety margin to the deficit limit of three percent of GDP. The reference path ensures that fiscal adjustment is continued until the deficit reaches a structural stability margin of 1.5 percent of GDP. The annual improvement of the primary structural balance needs to be at least 0.4 percentage points of GDP until the required margin is reached and can be reduced to 0.25 percentage points of GDP if the adjustment period is extended.
The member states are required to integrate the net expenditure path approved by the Council of the EU into their fiscal-structural plan. Control accounts monitor deviations from these paths. An extension of the plan up to seven years is possible if the member state in question commits to reforms and investments that increase its economic resilience and growth potential and correspond to priority EU objectives such as the green and digital transformation, energy security and strengthening defence capacities
The excessive deficit procedure (EDP) has also been reformed. A debt-based procedure can be initiated when the ratio of government debt to GDP exceeds the reference value, the budgetary position is not close to balance or in surplus and the deviations recorded in the control account of the member state exceed either 0.3 percentage points of GDP annually or 0.6 percentage points of GDP cumulatively (Council of the European Union, 2024).
Germany’s expenditure plans
Germany is planning extensive new spending in various areas. These include:
▪ Increased defence spending: In February, the then defence minister Boris Pistorius indicated that German defence spending could increase in future to between three to 3.5 percent of GDP (CNBC 2024). According to SIPRI, Germany spent 1.9 percent on defence in 2024.
▪ To increase infrastructure spending a special fund will be created with a volume of 500 billion euros over a period of twelve years. In Germany’s coalition agreement, the coalition partners agreed to make investments totalling 150 billion euros over the legislative period of four years, most of which are additional investments. 2 Although the exact modalities have not yet been clarified a phased increase is to be expected. Linearly, this
2 The exact volume still needs clarification. In 2024, the investment spending of the federal government amounted to twelve percent of expenditure. At least ten percent has been given as a reference size. This means that initially around five billion euros per year of planned federal investments could be financed by the special fund without constituting additional investment. It remains to be seen whether and to what extent this option is used
would break down to annual additional investments of 37.5 billion euros on average which corresponds to about 0.8 percent of German GDP.
▪ Germany’s new black-red coalition also plans extensive relief measures. Plans include temporary degressive depreciation for businesses (30 percent over three years), a phased reduction of the corporate tax rate from 2028 onwards and a package to reduce energy costs, including a reduction of the electricity tax rate, a cap on grid fees and possibly the introduction of an industrial electricity price, financed by the levy on CO2. In addition, plans include several tax relief measures and increased spending on pensions.
Compatibility of Germany’s expenditure plans with the EU fiscal rules
In its latest growth outlook for Germany of November 2024, the European Commission forecast a budget deficit of 2.2 percent of GDP and a debt ratio of 63 percent of GDP for 2024. This means that Germany was above the Maastricht limit of 60 percent last year already and therefore needs to achieve a phased reduction of its debt level in accordance with the European fiscal rules.
The Annual Progress Report 2025, based on the government draft of the federal budget 2025 of 17 July 2024, the federal government’s annual projection of overall economic development of 29 January 2025 and the calculations of the committee for tax revenue forecasts of 22 to 24 October 2024, even estimates a higher budget deficit for Germany than the European Commission of 2.8 percent of GDP in 2024. For the current year, the deficit is expected to be slightly lower at around 2.5 percent of GDP. The report also forecasts a moderate increase in Germany’s government debt ratio. For 2025, the structural primary balance is expected to improve slightly from minus 0.8 to around minus 0.5 percent of GDP. Net primary expenditure is expected to drop from 3.8 percent in 2024 to around 2.5 percent in 2025, indicating gradual consolidation (though partly caused by one-off effects). According to the report, Germany’s moderately restrictive fiscal course corresponds to the recommendations of the Council for the euro area.
However, this forecast is based on the old government draft, a forecast for growth in 2025 that has meanwhile been downwardly adjusted by 0.3 percent by the transitional government, which is more realistic (forecast is zero growth 2025) and tax revenue estimates that have since been revised in a new tax revenue estimate of 15 May this year. In any case, it is very clear that in view of the persistent economic stagnation in Germany, the country’s fiscal scope in general is highly limited.
Germany could simultaneously conflict with three key European fiscal rules.
▪ Minimum reduction of the government debt ratio: As shown by Zettelmeyer (2025), the latest amendment to the constitution regarding the debt brake, which provides for additional net borrowing for security and infrastructure spending and by federal states, may not conform to the fiscal rules of the EU. Even though government debt would remain sustainable in the long term or will stabilise, as the German debt brake model defines a structural deficit which also factors in interest payments for loans outside of the 0.35 percent limit. That means that expenditure that is formally excluded from the deficit limit, such as defence, also needs to be counter-financed elsewhere in the budget. However, Zettelmeyer (2025) points out that if the new scope for debt is used in full, and assuming nominal growth rates of between two and three percent and defence spending of 2.5 to 3.5 percent of GDP, Germany’s government debt ratio could rise to between 61.7 percent and 142.5 percent in the long term. This development would contravene the obligation anchored in the EU Treaty to reduce debt ratios over 60 percent successively down to this threshold. Without supporting consolidation measures, Germany’s debt level is in danger of structurally drifting off course.
▪ Ensuring the deficit resilience safeguard: Even though the reformed German debt brake formally defines a limit for structural deficit of 0.35 percent of GDP at federal level, securityrelated expenditure in excess of one percent of GDP and investments made through the
new 500 billion euro special fund are exempted from this, which factually expands Germany’s national fiscal scope. Even if the national escape clause provided by EU law is activated, which allows for the exemption of defence spending above the level of 2021 (around one percent of GDP) up to a maximum of 1.5 percent of GDP, the European stipulations will still be a very tight fit. According to the Bruegel Analysis (Steinbach and Zettelmeyer 2025), in the base scenario Germany would have to have a primary surplus (without security spending) in 2025 of at least 0.21 percent of GDP above what the reformed debt brake allows, which is a restrictive requirement. In addition, according to the EU rules, Germany needs to present a medium-term fiscal-structural plan that sets out a path to reach a structural primary surplus of over 0.1 percent of GDP by 2031 (the target year) if it chooses a seven-year adjustment phase (0.4 percent in case of a four-year plan). This would require annual consolidation steps of around 0.13 percent of GDP based on a deficit of 0.8 percent in 2024 as estimated in Germany’s Annual Progress Report. According to EU rules, the net borrowing for the expenditure under the special fund would be included in full as well as the additional 0.35 percent of GDP of lending scope for all federal states together.
▪ Sticking to the net expenditure path: Germany has so far not presented a fiscal-structural plan with a binding net expenditure path. On account of the early federal government elections, the federal government arranged to postpone the deadline with the European Commission in autumn 2024. The analysis of Steinbach and Zettelmeyer (2025) suggests that the EU fiscal rules will provide almost no additional scope for spending on infrastructure out of the special fund even with the activation of the national escape clause for defence spending unless this additional spending is compensated for by cuts to other items. The new German rule on security spending is also subject to European requirements: Although Germany can probably benefit from the Commission's flexibility with regard to higher core defence spending, according to the Bruegel analysis, additional security-related spending would also have to be cut or offset by counter-financing. Once the Bundeswehr special fund expires in 2027, at the latest, the federal government will have to tackle the task of reaching the aspired level of spending for security with the currently small core budget (around 1.2 percent of GDP), net borrowing of up to 1.5 percent of GDP additionally and an amount above the 2.5 percent (1.5 percent plus one percent reference year) that needs to be fully consolidated if the core budget is not lifted beforehand. Another point that needs to be clarified for the 2029 budget is whether Germany will be able to continue using the national escape clause.
The spending and tax plans outlined in the coalition agreement may not conform to the stringent fiscal rules of the EU. Activating the national escape clause in the Stability Pact will help with the financing of additional loan-financed security spending but will be fully included in the debt ratio, deficit and debt sustainability calculations. By activating the national escape clause, Germany will receive additional spending scope of up to 1.5 percent of GDP for defence above the net expenditure path defined by the Council of the European Union. However, this leeway is only granted if the minimum requirements of the new deficit and debt safeguards are met (i.e. a certain degree of fiscal adjustment is mandatory). If Germany does not meet the deficit limit of three percent or deviates from the net expenditure path despite these adjustments the European Commission can decide not to initiate an excess deficit procedure if the excess has clearly been caused by defence spending and does not appear to endanger fiscal sustainability.
The additional spending for infrastructure could easily bring public spending to the limit of the net expenditure path and the deficit safeguard if other consolidation measures are not taken. This also applies to lower revenue at federal and federal state level caused by the relief measures for households and businesses in income and value added tax.
Even with radical reforms to increase potential growth (for example, on the labour market, in investment or in technical progress through innovation-related measures), in so far as these are
planned and implemented by the coalition, it would still not be certain that these will be taken into account by the European Commission in calculating Germany’s debt sustainability.
Labour market and employment still robust
The labour market in the euro area is still looking robust despite the less dynamic overall economic environment. In 2024, overall employment (domestic concept) increased by one percent, bringing employment among 20- to 64-year-olds in the EU to 75.8 percent. This corresponds to 197.6 million people and is the highest employment rate since 2009, when this indicator was first measured. In manufacturing, in contrast, employment as good as stagnated, recording a minimal drop of 0.1 percent. Employment in construction continued on a positive trend, rising another 1.2 percent following an increase of 2.4 percent in 2023.
A look at the four largest economies in the euro area shows that employment in Spain rose the most in 2024, climbing 2.2 percent, followed by Italy with a 1,7 percent rise. In France, employment increased by 0.6 percent while in Germany it basically stagnated, creeping up just 0.1 percent.
Employment* in the euro area
*Rate of change, seasonally adjusted
Sources: Macrobond, Eurostat
The unemployment rate in the euro area remained at a historically low level. In March 2025, it was at 6.2 percent, unchanged since September 2024. Youth unemployment (people under 25) is still much higher and was at 14.2 percent at last count. Regional differences remain large. While countries such as Germany and the Netherlands have very low unemployment rates (3 5 and 3 9 percent), unemployment is still comparatively high in Spain and France (10.9 and 7.3 percent). The latest figure for unemployment in Italy was six percent.
Monetary policy of the ECB less restrictive but financing conditions still becoming less favourable
Development of inflation
In April 2025, inflation in the euro area continued to move closer to the two percent target of the European Central Bank, according to the first estimate. Overall inflation stood at 2.2 percent while core inflation, which excludes the more volatile energy and food prices, was slightly higher at 2.7 percent.
Risk Analysis
Overall, both the short-term and the medium-term risks for the economic outlook in the euro area point downwards.
Downside risks:
▪ Trade tensions and fragmentation: An increasing escalation of trade tensions and continuing uncertainty regarding trade and investment policy could further curb global trade, make supply chains more fragmented and accelerate the restructuring of global value chains. Although some countries would be able to reorganise their position in the supply chains, this fragmentation would still pull down growth overall, particularly in the strongly export-oriented economies in the euro area (including Germany, the Netherlands, Austria, Ireland and Belgium).
▪ Geopolitical tensions: Current and intensifying geopolitical conflicts such as the Ukraine war and tensions in the Middle East could once again cause commodity prices to rise, increasing inflationary pressure and further diminishing the already weak level of business and consumer confidence. These geopolitical risks constitute a substantial downside risk for economic development and could further dampen growth in the euro area.
▪ Financial market risks: Persistent inflation or new price shocks could force the central banks across the world to keep interest rates up longer, which could increase volatility on the financial markets and trigger capital outflows from emerging countries. This could lead to a deterioration of the terms and conditions of financing and burden the economies of third countries, which could, in turn, have a negative impact on the euro area and specifically on trade relations and capital flows. Higher long-term bond yields could additionally constrict the fiscal scope of highly indebted countries, with the potential of adding strain to the global financial markets.
▪ Setbacks in international cooperation: A decline in international cooperation, particularly in development cooperation and climate protection, could exacerbate social tensions in fragile countries and lead to instability (IMF 2025). This could curb global growth and indirectly weigh on the euro area through trade ties, investment and increasing geopolitical tensions, possibly further reducing the growth potential of the euro area.
Growth opportunities:
▪ New trade agreements: Progress in trade initiatives could open up new markets and facilitate trade, which would reduce uncertainties and boost economic growth. Stable trade relations could encourage businesses to make long-term investments which would, in turn, increase economic activity and employment. Trade agreements can also improve access to resources and technologies which would strengthen the competitiveness and resilience of the euro area.
▪ Conflict resolution: An end to current geopolitical conflicts, such as in Ukraine, would nurture economic growth considerably. A stabilisation of energy prices would lighten the load on businesses and consumers. Higher confidence in regional stability could also attract investment and reduce uncertainties. Being highly exposed to energy imports and geopolitical developments, Europe would stand to benefit especially from these positive effects.
▪ Structural reforms: Accelerated implementation of structural reforms, particularly the deepening of the internal market and the capital markets union could boost investment, which would increase productivity growth and thus strengthen the competitiveness of the European economy. A more integrated internal market would reduce trade barriers, and a deeper capital markets union would facilitate the access of companies and start-ups to financing.
The economic prospects of the euro area are currently marked by substantial downside risks. On the upside, progress in trade agreements, the resolution of geopolitical conflicts and the implementation of structural reforms could significantly strengthen the growth potential in the euro area and contribute to economic recovery.
Outlook and policy recommendations
The growth outlook for the euro area in 2025 is marked by two contrary developments. On the one hand, the new US import tariffs and the possible escalation of retaliatory measures are a direct burden on the European economy. The resulting trade barriers tangibly stifle the export sector and increase the uncertainties for businesses, with negative consequences for investment and consumption
On the other hand, fiscal policy in Europe is undergoing a strategic realignment towards higher spending on defence and infrastructure, in particular. This impetus will take some time to unfold, considering the usual planning and tendering involved in large projects and preceding implementation. The boost to economy activity generated by higher spending will therefore be felt some way down the line while the curbing effect of trade policy tensions will already hit in the short term.
Overall, we expect growth to reach 0.8 percent in 2025. The main drivers of growth are a robust labour market, a gradual pick-up in private consumption following on from rising real wages, monetary policy stimulus and the first effects of higher public spending. At the same time, downward pressure will
reforms on the labour market, product markets and financial markets with much greater resolve if they are to increase productivity, mobilise investment and strengthen economic resilience. That includes the swift expansion of the capital markets union to facilitate cross-border financing flows and better mobilise private investment across Europe.
▪ Drive regulatory relief at EU and national level: The EU and its members states should systematically reduce regulatory burdens, particularly regarding reporting duties and supply chain regulation. Less bureaucracy fosters entrepreneurial initiative, accelerates investment and strengthens the competitiveness of Europe. More than 60 percent of EU companies regard excessive regulation as an impediment to investment (BusinessEurope 2025), underlining the need to substantially reduce the regulatory burden. The European Commission’s omnibus package to simplify the EU’s legal framework for sustainability is an important step in this direction. European legislators must use this time to substantially improve directives with clear amendments that ease their implementation.
▪ Deepen internal market, particularly for services, energy and digitalisation: A fully integrated internal market is of crucial importance for high productivity and economic resilience in Europe. A top priority should be the swift expansion of cross-border energy and digital infrastructure and the reduction of remaining national barriers, particularly in the service sector, to tap into growth potential, boost competitiveness and accelerate the transformation towards a sustainable and digital economy.
▪ Swift and industry-friendly implementation of the Clean Industrial Deal: With the policy framework of the Clean Industrial Deal now in place, a resolute and accelerated implementation must now follow. This includes swifter planning and approval procedures, effective protection against carbon leakage, targeted support for key technologies and internationally competitive energy prices. Reliable transformation incentives are also important in order to make climate-friendly investments economically viable. This is the only way to marry decarbonisation with industrial strength and international competitiveness.
▪ Safeguard open markets and expand strategic trade relations: The EU should rapidly enter into further trade agreements with partners such as ASEAN and India and resolutely implement existing agreements. Diversified supply chains and improved market access are crucial determinators of economic resilience and growth opportunities. The European economy must not put itself at the mercy of geopolitical interests. The EU must strengthen its alliances with other large trading partners and safeguard a coordinated response to international trade diversion effects.
Sources
Banque de France (2025). Macroeconomic interim projections. March. Paris.
Banco de España (2025). Macroeconomic projections and quarterly report on the Spanish economy. March. Madrid.
Federal Ministry of Finance (BMF) and Federal Ministry of Economics and Climate Protection (BMWK) (2025). Annual Progress Report 2025. April. Berlin.
BusinessEurope (2025). Reform Barometer. March. Brussels
CNBC (2024). Germany’s defense minister says NATO’s 2% target is just the start: ‘We’ll probably need more’. February New Jersey
Confindustria (2025). Uncertainty and tariffs deteriorate the picture even if rates and energy prices fall. April. Rom.
Deutsche Bank Research (2025). Euro Weekly Digest: Survey data paint a mixed first picture of the post-tariff world. April. Frankfurt.
(2025b). France: GDP, PMI and a pinch of salt. Focus Europe. April. Frankfurt.
---(2025c). Focus Germany Four key questions. March. Frankfurt.
---(2024d). ECB Reaction: Follow the data Focus Europe. April. Frankfurt.
European Commission (2025). Acting on defence to protect Europeans. March. Brussels.
---(2025b). Questions and answers on ReArm Europe Plan/Readiness 2030. March. Brussels
---(2025c). Accommodating increased defence expenditure within the Stability and Growth Pact. Communication. March. Brussels
---(2024). Autumn 2024 Economic Forecast: A gradual rebound in an adverse environment November. Brussels
European Central Bank (2025). Vierteljährliche Zahlungsbilanz und Auslandsvermögensstatus für den Euroraum: viertes Quartal 2024 Pressemitteilung. April. Frankfurt.
---(2025b). Monetary policy decisions. Press release March Frankfurt.
(2024c). Monetary policy decisions. Press release. April. Frankfurt.
---(2024d). Euro area bank lending survey. April. Frankfurt.
Joint Economic Forecast (2025). Frühjahr 2025: Geopolitischer Umbruch verschärft Krise – Strukturreformen noch dringlicher Kiel Institute for the World Economy April. Kiel.
Zettelmeyer J. (2025). Can Germany afford to take most defence spending out of its debt brake? Bruegel. March. Brussels
Imprint
Federation of German Industries e.V. (BDI)
Breite Straße 29 10178 Berlin
T: +49 30 2028-0 www.bdi.eu
German Lobbyregister Number R000534
Author
Frederik Lange
T: +49 30 2028 1734 f.lange@bdi.eu
Editorial / Graphics
Dr. Klaus Günter Deutsch T: +49 30 2028 1591 k.deutsch@bdi.eu
Marta Gancarek
T: +49 30 2028 1588 m.gancarek@bdi.eu
This report is a translation based on „Wachstumsausblick Europa – Mai 2025, Protektionismus als Konjunkturbremse | US-Zölle belasten die wirtschaftliche Erholung Europas“, as of 15 May 2025