Jacob Kirkegaard harbors no doubts about what’s next for the European Central Bank as it notches the fifth cut in its key rate since June and leaves to door wide open to more at its next meeting and more. In fact he says a persistently weak Germany economy, a weakening global economy that won’t be eager to purchase EU products, and fiscal austerity across the euro area likely seal the deal for the ECB to stay on its rate-cutting path for the rest of the year and maybe in into 2026. Surprisingly he does not list the threat of President Trump imposing tariffs there, and says it could hurt U.S. more than it does the E.U.
Jacob is quick to bring Ukraine into the picture. As the war with Russia drags on, with each side still determined to finally beat the other into submission, he says the uncertainty this fuels is likely to reinforce consumers inclination to save rather than spend, and keep a damper on an a potential driver of the economy.
So dive in and hear what Jacob has to say as he weaves together the EU’s economy, fiscal dynamics and geopolitics with the ECB’s path in 2025 and beyond.
Not easy to pin down the Euro Area neutral rate 00:01:30:08 - 00:01:58:15
…The debate over what is the neutral rate in the euro area, dare I would say <has> ranges… there's a variety of them. Christine Lagarde said implicitly again today at the press conference that she believes that the rate that the neutral rate in the euro area is somewhere between 1.75% and 2.5%.
The neutral rate is a benchmark not target 00:01:58:17 - 00:02:51:08
But of course, the question, you know, whatever you think the neutral rate is, the question is, should the ECB go above or below it? And my view certainly is that, you know, the baseline for the economy should be that the other factors fiscal and, you know, external demand will be so weak that the ECB will have no choice but to go below the neutral rate, which means that I think as we get into the second half of 2025 rate cuts will continue potentially even depending on the exact speed also into 2026, which in my opinion mean that we're looking at a terminal rate in the eurozone somewhere between one and one and a half percent for this easing cycle.
Germany is extremely weak 00:04:22:09 - 00:04:49:17
…everyone is looking at the European economy... And I don't think a lot of people realize, for example, how weak Germany is…It's the largest economy in the euro area. It's also one of the biggest exporting countries when it can be. And, of course, for a while that's been getting weaker. So break that down a little bit more. When you look at German growth, when you look at some of the other countries… the domestic factors…that could be pushing growth higher and they're not.
Euro-Area role reversal 00:04:49:18 - 00:05:19:13
Why is that and how severe is it? Look, I mean, it's sort of in geographic terms, the eurozone right now is actually experiencing something quite extraordinary because the two weakest economies in the in the eurozone are France and Germany, whereas those that are growing much faster were some of the crisis economies during the eurozone crisis, particularly Spain, Portugal, to a lesser extent, also Italy.
Germany recoils from an energy price sucker punch 00:05:52:03 - 00:06:30:06
Germany has been disproportionately affected by the energy price shock that happened after the Russian invasion of Ukraine. So you have really seen a significant decline in German industrial production and particularly energy intensive production, you know, somewhere between 15 and 20% over the last couple of years.
Fiscal issues haunt key members 00:07:17:04 - 00:08:47:72
Of course, there is an election in Germany next week, so next month. So maybe this will provide some clarity. Starting next year in 2026. Another big problem in the eurozone is France. There in France, I would say the problems are more political. They're almost exclusively related to fiscal policy… usually we think of the biggest fiscal problem in the Eurozone is Italy. But actually Italy, it's true, has a very high debt, but it also has it tends to run primary surpluses. It actually tends to run fairly conservative fiscal policies. France is the opposite. France has for a number of years…pretty much the entire euro era, run significant fiscal deficits. Since 1999, French public debt has doubled. when the euro began in the late 1990, as French and German debt levels were essentially the same, just around just above 60% of debt to GDP. Well, today, Germany is about 70% and or little actually somewhat in the middle. But France is double at about 120%. France has a fiscal deficit of about 6% < of GDP>.
Monetary policies are watching and waiting focused on US Policy-00:10:18:18 - 00:10:54:07
I actually. Yes. It's a further potential complication for the euro area, particularly the ECB. And I think part of the reason why they're not being more aggressive on cutting rates is because they want to, you know, wait and see what happens, you know, in the transatlantic political security and economic relationship, which, by the way, in my opinion, is not that different to the approach of the Federal Reserve that are also waiting to see what happens on fiscal policy and other things in the United States.
Trade wars will have many repercussions if they arise 00:11:26:14 - 00:11:58:00
You know, if there is a trade war, I don't think Trump will impose tariffs only on Europe. If there is tariffs on Europe, it will be because Trump has imposed tariffs on pretty much anybody in the world, including Europe, and that is, in my opinion, quite potentially inflationary decision for the U.S. economy. I think this will drive up U.S. interest rates and with it the dollar by.
Europe many not be as disadvantaged as it seems in a trade war 00:13:05:17 - 00:13:36:04
So, you know, this idea that Europe, because it has a trade surplus, cannot win a tariff war or a trade war with the United States. I don't think that's true. Once you look beyond just the trade balance and look into the broader macroeconomic circumstances of such a such a trade centric call center conflict. So, you know, I hope it doesn't come to this.
But there are also important policy linkages to consider 00:13:36:06 - 00:14:05:14
But I will also say that I by the way, I do think that Europe, by the way, even if it did care, even if it did come to it, I think Europe would be relatively hesitant in responding to it because of the complicating factor of the transatlantic security relationship and the urgent European interest in keeping Trump quote unquote, onside when it comes to continuing to support Ukraine.
Euro-Area growth limited by weak external demand and fiscal drag 00:15:13:24 - 00:15:56:08
<I see growth> somewhere between 1.1% to 1.5% annually… I don't think the euro area will be able to grow <much stronger in the> medium term without further monetary stimulus. And the reason for that is that Europe isn't going to get a boost from external demand. I believe that or at least if we believe current budget forecasts, the fiscal impulse in the eurozone will be negative in 2025.
Ending the war in Ukraine will not be easy 00:19:11:16 - 00:20:24:12
Maybe <Trump’s efforts will> win him a Nobel Prize and all of that. Who knows? But it's very difficult to end a war if you're not actually fighting in it. And obviously, the U.S. is not. And it's even more difficult to end the war if neither of the two sides are particularly interested in stopping fighting right now. And I don't think, you know, neither Russia nor Ukraine is interested in stopping the fight, because if Ukraine were to stop the fight right now, they would obviously do it in a position at a time when Russia has conquered quite a lot of a lot of their territory. But more importantly, Ukraine is fully funded, certainly throughout 2025. Meanwhile, Ukraine is also, from a military point of view, is in a considerably better position than it has been in terms of supplies for many months. The Biden administration shipped a lot of weapons to to Ukraine, but perhaps even more importantly, Ukraine, domestic military capabilities are rising very rapidly.
Ukraine is having some war theater success 00:20:58:00 - 00:21:38:10
…the Baltic Sea export terminal for Russian crude has basically been receiving zero inflows for the last couple of days. And what this what this tells you is that Ukraine seemingly is increasingly able to hit and destroy Russia's critical energy infrastructure. And obviously, if Russia's oil exports are significantly severely restrained, this will pose, you know, very dramatic negative implications for Russia's ability to finance this war.
War to last into 2026 00:23:51:04 - 00:24:18:07
I think this war goes on for probably the rest of this year into 2026. Okay. And then we will see. But I can I continue to believe that time is not Vladimir Putin's friend. And ultimately, Trump will, I think, conclude that it is in his personal political interest to help Ukraine to win, because that makes it that makes him a winner.
Euro-Area growth will be weak, but it will be supported… 00:25:30:15 - 00:26:49:01
I think that, <the Outlook> is a bit of a it's a bit of a paradox because historically speaking, European labor markets are very, very strong. We still have the lowest unemployment rate ever, even in countries such as Italy. I actually I actually think that will continue. I don't predict any particularly significant increase in unemployment rates in the eurozone. And this puts, if you like, a floor under any forecast. There is simply it's very difficult to generate a cyclical downturn when you have, you know, record low unemployment, record high employment and rising and rising real wages.
Jacob Kirkegaard
Senior Fellow at Peterson Institute for International Economics (PIIE)
Jacob Funk Kirkegaard, Senior Fellow, has been associated with the Institute since 2002. Before joining the Institute, he worked with the Danish Ministry of Defense, the United Nations in Iraq, and in the private financial sector. He is a graduate of the Danish Army's Special School of Intelligence and Linguistics with the rank of First Lieutenant; the University of Aarhus in Aarhus, Denmark; the Columbia University in New York; and received his PhD from Johns Hopkins University, School of Advanced International Studies. He is coeditor of Transatlantic Economic Challenges in an Era of Growing Multipolarity (2012), author of The Accelerating Decline in America's High-Skilled Workforce: Implications for Immigration Policy (2007), coauthor of US Pension Reform: Lessons from Other Countries (2009) and Transforming the European Economy (2004), and assisted with Accelerating the Globalization of America: The Role for Information Technology (2006). His current research focuses on European economies and reform, foreign direct investment trends and estimations, pension systems, demographics, offshoring, high-skilled immigration, and the impact of information technology.
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