Europe Faces Economic and Political Headwinds Next Year

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As the U.S. economy keeps on humming, Europe has a far tougher economic outlook. Problems new and old are combining to slow growth in the 20-member club of nations that use the euro, the world’s No. 2 economy when taken as a bloc.

Actual recession in the eurozone is unlikely. Just slow and uneven growth ahead in 2025. Business sentiment across the bloc is negative. Ditto for consumer sentiment, despite rising paychecks. Inflation remains higher than it should be, as in the U.S., though similarly to here, it is easing, in fits and starts, allowing the European Central Bank to lower interest rates fairly quickly next year. (Note that that will keep the euro weak vs. the dollar, since the Federal Reserve won’t be cutting as fast.)

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Now, trade tensions loom over Europe, whose economy depends heavily on trade. 40% of GDP in the eurozone stems from exports within and beyond its boundaries. President-elect Donald Trump says that he is considering levying tariffs of 10% to 20% on goods imported from Europe, threatening sectors like cars, chemicals, machinery, food and drugs. The EU can probably work with the new U.S. administration on trade issues. Trump threatened steep tariffs on European imports during his first term, but decided to hold back most of them in favor of more-targeted levies. European political leaders will hope to again negotiate with him, perhaps starting with offers to buy more LNG — liquefied natural gas — from the U.S., an American export that Trump wants to foster.

A U.S.-China trade war would also hurt Europe, in two different ways. U.S. tariffs on Chinese goods would weaken China’s economy, a key export market for Europe. And reduced access to U.S. consumers would likely force Chinese sellers to expand in Europe by cutting prices, further pressuring European manufacturers.

Meanwhile, domestic politics and geopolitics keep worsening for Europe. The eurozone’s biggest economies, Germany and France, face political paralysis as each tries to assemble new governing coalitions. Fiscal strains in both countries caused their respective governments to fall recently, with little sign of a consensus on how to cut spending, raise taxes or otherwise deal with their rising debt loads.

Look for European nations to spend more on defense, as Russia’s war on Ukraine drags on and Donald Trump pushes NATO members to spend enough on defense to meet the NATO treaty’s 2%-of-GDP rule. Most members do so already, but with Washington likely to pull back on aid to Ukraine, Europe will be forced to play a bigger role in deterring Moscow and keeping Kyiv fighting — no easy task for a group of countries mired in slow growth and political turmoil. None of this bodes well for Europe as a market or investment destination for U.S. goods or dollars.

This forecast first appeared in The Kiplinger Letter, which has been running since 1923 and is a collection of concise weekly forecasts on business and economic trends, as well as what to expect from Washington, to help you understand what’s coming up to make the most of your investments and your money. Subscribe to The Kiplinger Letter.