Spain set for sunny outlook within eurozone economy in 2025

S&P Global Ratings recently released its eurozone economic outlook for the first quarter of next year, estimating that gross domestic product (GDP) growth in the eurozone this year will be 0.8%, while increasing to 1.2% next year. 

Spain's economic performance is expected to be resilient, while Germany is likely to experience dampened economic growth. 

Next year, inflation is likely to be slightly lower at 2.4%, down from a previously anticipated 2.5%, mainly because of a more marked fall in energy prices.

However economic and geopolitical risks still remain for next year, especially as new government leaders in the EU, US and Germany may make significant changes to defence spending and tariffs in 2025.

Germany likely to continue underperforming in first quarter of 2025

S&P Global expects German GDP growth to be approximately 0.4% year-on-year in the first quarter of next year, significantly less than the eurozone's expected GDP growth rate, at 1.2%. Similarly, Italy is also expected to lag, at 0.7%. 

Regarding the reasons behind Germany's expected underperformance early next year, Sylvain Broyer, chief EMEA economist at S&P Global Ratings, said in an email note: "This reflects a crisis of confidence, driven by the late recognition that Germany’s economic model is no longer viable. 

"The model - relying on exporting medium-innovation products to the US and China, powered by cheap energy and labour - is now a thing of the past. This shift comes amid a rapidly aging workforce and political stagnation."

Robust industrial production and strong employment boosting Spanish growth

Coming to what is driving Spain's economic rebound, Broyer said: "Spain's outperformance is multifaceted. The post-pandemic normalisation of tourism is not the only reason for this. Industrial production is continuously expanding in Spain. Last year, consumer spending was the main driver of growth, adding one percentage point of a 2.5 percentage-point increase in Spain's GDP. 

"Second-round effects on core inflation have also been more muted in Spain than in many other countries. Stronger employment growth, stimulated by labour market reforms aimed at replacing limited-term employment contracts with open-ended ones, is another explanation. 

"The dynamism in employment does not hinder productivity growth, in contrast to the other three major economies of the eurozone – Germany, France, and Italy. What's more, Spanish households have deleveraged and are now no more indebted than their German counterparts, with a debt-to-income ratio of 85% versus 128% in 2012."

Broyer further highlighted that Spanish households have also already made considerable changes to their mortgage financing, now leaning more towards fixed interest rates, rather than the previously preferred variable rates. 

In turn, this has also meant that they are now less vulnerable to changes in monetary policy than before. Savings rates for Spanish households have also returned to 2019 levels. 

However, other southern European countries like Italy are unlikely to do as well as Spain, according to Broyer, mainly because of the government's 'superbonus' winding up, causing Italy to trail the rest of the eurozone. 

What could be the impact of the ECB cutting rates faster than expected?

S&P Global Ratings expects the European Central Bank (ECB) to now slash interest rates quicker than anticipated, mainly because of ongoing dampened confidence, as well as more data supporting disinflation progress. 

The main policy rate is expected to now touch 2.5% before next summer, significantly ahead of S&P's previous forecast of September 2025. 

Coming to how quicker rate cuts by the ECB might impact this outlook, Broyer said: "Faster rate cuts could help boost confidence, which remains surprisingly depressed despite the return of growth, disinflation and full employment. As a result, faster rate cuts would support the recovery in consumer spending and investment, which remain the mainstays of the European recovery."

What impact will decisions on tariffs, spending and defence made by the EU and US have?

Broyer also said: "If EU and NATO members meet the NATO target of 2% military spending as a percentage of GDP per year, growth could improve by as much as 0.4%. The question is when.

"There is nothing positive about higher trade tariffs, for anyone. That said, Europe could be in for a lesser evil, if it suffers fewer tariff rises than China, Canada or Mexico, and if these are offset by a lasting appreciation of the dollar. 

"The real issue for Europe is what effect, and when, the measures put in place by the new administration will have on US and Chinese GDP. The US and China are our main two trading partners, absorbing 27% of EU exports."

Regarding the impact of higher tariffs on advanced and emerging economies, Marie Diron, the managing director of Global Sovereign Risk at Moody’s Ratings, also said in an email note: "Higher US tariffs could spark renewed inflationary pressures and monetary policy tightening, which would hurt US growth and its fiscal trajectory. 

"Advanced and emerging economies where exports are a key growth driver, such as Germany and Korea, would stand to lose the most from an escalation in trade tensions. 

"European economies deeply integrated in Germany's supply chain would also be hit as a result. Some emerging markets will continue to benefit from the global reconfiguration in supply chains, although this will make it more difficult to allocate goods efficiently and will increase costs."

Western European growth may rise to almost pre-pandemic levels in 2025

Moody's Ratings also recently released their Global Sovereign Outlook 2025, outlining that, although sovereign credit fundamentals for next year are expected to be stable, the leeway to respond and adapt to unexpected shocks has lessened. 

Government efforts to slash debt and meet economic goals are also likely to be hampered by tight budgets, ongoing geopolitical tensions and mounting social risks. 

However, growth is still expected to be resilient, helping governments focus more on some long-term objectives. 

Regarding the outlook for advanced European economies next year, Diron pointed out: "The credit outlook for advanced European economies is contrasted. 

"Growth will rise to close to pre-pandemic levels of around 1.5% across many parts of Western Europe including Austria, Netherlands and Switzerland thanks to a gradual recovery in manufacturing, supported by firmer global demand and easing policy. 

"We expect only some moderation in growth in countries like Spain, where a strong labour market helped it outperform peers in recent years. However, while GDP growth will recover in Germany, it will remain hampered by structural challenges. Meanwhile, in the UK, limited fiscal room will curb the new government's attempts to address more than a decade of weak productivity."

Eastern Europe prospects

Coming to the outlook for Eastern European economies in 2025, Diron said: "Sovereigns in Eastern Europe also face contrasted credit conditions. GDP growth is moving towards trend rates, supported by EU funds. Deficits are narrowing gradually. 

"A number of sovereigns in the region are subject to the EU's excessive deficit procedures which fosters fiscal consolidation. However, Hungary is at risk of not implementing the conditions necessary to obtain the full amount of EU funds it has, in principle, access to. In case of an EU funding shortfall, the economy and government’s finances could be negatively affected.

"Moreover, the ongoing war between Russia and Ukraine will continue to pose significant risks. Reduced US support for Ukraine might increase European (Western and Eastern) governments' fiscal burdens as we expect governments to initially compensate for US support."