France, Europe and beyond: sizing up the year ahead

As 2024 draws to a close, economies across the Euro area are taking stock of the challenges and opportunities that next year is set to bring. Hadrien Camatte, Senior economist for France, Belgium, Eurozone, Benoit Gerard, Rates Strategist and Cyril Regnat, Head of Markets Research at Natixis CIB take a look at the economic environment that will shape global priorities in 2025

2025 looks set to bring challenges – both new and old – across the board. In France, new Prime Minister (PM) Francois Bayrou must grapple with an  unstable political environment to build a foundation from which he can enact a budget in 2025. In the Euro area more broadly, economies are looking to encourage growth, while at the same time preparing for a potentially hostile trade environment, spearheaded by the US. Meanwhile, with inflation reaching target levels, the European Central Bank (ECB) and the Federal Reserve (Fed) look set to continue cutting interest rates, but at a cautious pace.

The Euro area enters 2025 with a cautiously optimistic economic outlook. Inflation has returned to around 2%, reflecting successful monetary tightening over the past year. That said, challenges remain: wage-driven service inflation persists, and structural headwinds – including geopolitical risks and trade tensions – could temper growth.

The ECB has adopted a gradual approach to rate cuts, and we target a terminal rate of 2% by mid-2025. While the central bank’s ‘meeting-by-meeting’ policy shows caution, balancing vigilance against inflation, it also acknowledges the economic downside risks. The broader goal is to sustain growth while mitigating potential stagflation.

Forecasts suggest GDP growth in the Euro is positive and will edge closer to that of the US in the coming years, with a projected rate of 1.2% in 2026 compared to 1.7% in the US. However, these projections hinge on key assumptions – including the hope that protectionist US trade policies under a Trump administration will remain more rhetoric than reality. Escalation into a full-blown trade war could, however, derail these prospects and push the region into recession.

As France attempts to establish a new government, the country remains in a state of political turmoil. Following the ousting of PM Michel Barnier, new PM Francois Bayrou has been tasked with forming a functional coalition. A special finance bill has been voted, laying the groundwork for a 2025 budget aimed at stabilising public debt and maintaining essential government functions.

Political uncertainty has certainly taken its toll on market confidence: Moody’s downgraded France from Aa2 to Aa3, underscoring that political fragmentation is more likely to impede meaningful fiscal consolidation. The economic momentum could suffer from political and fiscal uncertainty as already indicated by several business surveys: the French central bank reduced their 2025 growth prediction from 1.2% to 0.9%, which is also the Natixis CIB forecast.

There is some room for optimism, however. France's sovereign bonds (OATs) remained broadly stable since the snap election, with recent downgrade from Moody’s eliciting a limited reaction from the market – despite its unexpected timing and ongoing uncertainty as to whether Fitch and S&P will follow suit. Looking forward, analysts remain reasonably optimistic, as the OAT spread remains stable and new sovereign debt is being sold at bit-to-cover ratios that match or slightly exceed historical averages.  

Fundamentally, France also remains a strong and diversified economy with significant demographic advantages compared to its EU neighbours. Italy’s population, for example, is expected to shrink from 60 million to 50 million by 2060. Private consumption is expected to recover in export market shares with improved market conditions for fuel and airbus exports, as well as tourism. French yields remain stable, and the country's bond market remains attractive with strong demand in primary markets. While France’s political situation remains fraught – and its new government has an uphill battle in terms of tackling public debt and ensuring fiscal stability – glimmers of optimism remain.

The ECB and the Fed have both signalled a shift towards monetary easing in response to easing inflationary pressures. The ECB has already reduced its deposit rate by 25 basis points while ensuring it remains tone-neutral in its messaging. Indeed, the ECB's data-driven ‘meeting-by-meeting’ approach looks to avoid sending out too strong a signal on either side, with signals both hawkish and dovish so far.

Market hawks value the prudency of this approach. By providing limited guidance on its plans for 2025, the ECB has indicated that the fight against inflation is far from over. Neutrality goes with an increasing risk of stagflation and the effect on rates remains uncertain. However, there are countersignals for the doves, as forecasts explicitly mention the downside risk to the cycle and activity validating future market pricing as the market falls below our estimation of 2% for the neutral rate in the euro area.

Such forecasts may finally convince the ECB to make more concessions to keep inflation under control through 2025. Given the context, there are also limited risk implications as the ECB now totally exits the bond market, opting in a previous decision not to reinvest in the Pandemic Emergency Purchase Programme (PEPP), which used to provide an important level of flexibility.

Across the Atlantic, the Fed has taken a more hawkish stance, opting for more gradual rate cuts. This is consistent with the ECB's own findings around limited progress on inflation: the Fed might pause its normalisation path in the first quarter of 2025. The new set of forecasts from the Fed also reflects the US economy's strong performance, with unemployment projected to remain at 4.3% for the next three years, mitigating an important volatility driver. As a result, US rates are expected to remain high, boosting the dollar but creating some uncertainty as scenarios range from a soft landing to no landing at all.

Ahead of 2025, the economic outlook remains clouded by uncertainties. Yet it is not entirely depleted of optimism. Inflation in the Euro area is in a better position than at the start of the year, but economic headwinds remain – and the potential trade war between the US and China has the potential to cause ripples across the global economy. In France, 2025 will be a vital year as PM Bayrou attempts to bring political stability and introduce a budget that will help cut France’s growing deficit, all while avoiding the same fate as his predecessor. The ECB and Fed have responded with mixed signals to this environment: rate cuts are expected in 2025, but the messaging from central banks has erred on the side of caution.