Economics

Germany has voted

It is good news that the CDU/CSU and SPD received enough votes in the federal election to form the new federal government as a coalition of two parties. This will speed up the coalition negotiations compared to a coalition of three parties and facilitate cooperation in the new government. Meanwhile, it seems to have been understood in Berlin that the current challenges for Germany are formidable, and so the coalition partners-to-be agreed just a week and a half after the election on extensive changes in fiscal policy, which were passed with the help of the votes of the Greens in the old Bundestag with a two-thirds majority. The reforms include exempting defence spending in excess of 1% of GDP from the debt brake, allowing the federal states to take on debt of 0.35% of GDP, and creating a special fund of EUR500bn for infrastructure spending over the next twelve years. The overdue investments in these two areas are thus financed for the foreseeable future. However, it remains essential that the new government, once sworn in, also launches urgently needed structural reforms to put the German economy on a sustainable growth path. These include reducing bureaucracy, social reforms, lowering corporate taxes and realigning immigration and energy policy. However, it will take some time for the planned additional spending and possible reforms to have an impact on the real economy, so we expect GDP growth in Germany this year to be a mere 0.2%, accelerating to 1.4% next year.

Trump jeopardises the recovery of growth in the eurozone

After the eurozone economy grew by just 0.2% quarter-on-quarter in the last quarter of 2024, the lights have recently turned green in some of the continent’s problem areas. France has finally adopted a budget for 2025 and Germany is likely to have a functioning government again relatively soon. The ECB’s decision to cut interest rates further and the fact that wages in the eurozone have been rising faster than prices for some time are also providing an economic tailwind. The mood among European companies has already brightened somewhat. However, the recovery is still on shaky ground, as global uncertainties have increased noticeably of late. On the one hand, the geopolitical threat to the euro area has increased significantly since the US turned its back on Europe and Ukraine in favour of Russia. On the other hand, Trump has not just left it at threats when it comes to tariffs, but has recently increased import duties on goods from China; Mexico and Canada could follow suit at the beginning of April. In addition to reciprocal tariffs for all trading partners, the US President has also announced import tariffs of 25% on goods from the EU. Reciprocal tariffs would be painful for individual sectors in Europe, such as the automotive industry, where the tariff differential between the EU and the US is not very high. However, the overall impact would be manageable. By contrast, a 25% tariff on EU imports would be much more devastating, and Brussels would likely respond with counter-tariffs. Such a trade conflict could derail the current positive momentum in the eurozone. The high level of uncertainty also makes it difficult for the ECB to form a clear picture of how economic and inflation trends will evolve this year. On 6 March, the guardians of the currency in Frankfurt cut the deposit rate by a further 25bp to 2.5%, but otherwise kept their options open. The fact that the ECB now describes its monetary policy as “perceptibly less restrictive” reinforces our view that it will hold fire on 17 April before cutting the deposit rate for the last time to 2.25% on 5 June. However, if the growth outlook for the euro area deteriorates significantly between now and then as a result of the trade conflict with the US, the ECB may be forced to cut rates further.

US economy is booming, but Trump’s policies harbour risks

The US economy is showing little sign of losing momentum. GDP grew at an annualised rate of 2.3% quarter-on-quarter in the fourth quarter, and although some recent economic indicators have been somewhat disappointing, the US economy as a whole appears to remain in fairly robust shape. The new administration is cutting regulations and looking to lower taxes. Both may continue to support the economy in the short term. However, aggressive immigration and trade policies are causing concern and pose significant medium-term risks to the US economy. Lower immigration will reduce the supply of labour and lead to higher wage inflation, especially in the service sector. High tariffs will also raise price levels in the US. If tariffs of 25% on goods imported from Canada and Mexico (and 10% on Canadian energy) are indeed imposed, combined with tariffs of 20% on imports from China, we expect this to add around 0.6ppt to US core inflation by the end of 2025. On top of the tariffs that have already been imposed, Trump is currently threatening a series of additional tariffs that would further increase the impact on US inflation. This would be bad news for the Fed, as core inflation has already been moving sideways at just above 3% for nine months. We therefore expect the Fed to leave the federal funds rate range at 4.25-4.50 and to refrain from further rate cuts. If President Trump follows through on his far-reaching tariff threats, the Fed may even be forced to raise rates again somewhat later in the year. Overall, we expect the US economy to post very solid growth of 2.6% this year. However, labour shortages and protectionism will increasingly weigh on economic momentum in the coming years. As a result, GDP growth is expected to slow to 2.2% in 2026 and 1.8% in 2027.