Euro Zone Economy Wraps Up 2025 on a Steady Note Despite Risks

By Balazs Koranyi

FRANKFURT, Jan 7 (Reuters) - Euro zone inflation slowed to 2% last month, capping a surprisingly benign year price-wise for the currency bloc, even as questions linger about the delayed impact of U.S. tariffs, German stimulus and geopolitical stresses.

The euro zone withstood unexpected turbulence from trade tensions, disappearing export markets and Chinese dumping last year, while domestic consumption finally kicked into gear and lower interest rates offered some relief.

But this resilience is unlikely to give way to a boom, especially since deeply rooted structural rigidities keep holding back growth and governments lack appetite for political compromise needed for deeper integration.

INFLATION IS LARGELY GONE

Still, taming inflation is a clear victory for a bloc of 350 million people as price growth eased to 2.0% last month, in line with expectation, and was likely to hold near this level for years to come.

A more important figure on underlying prices, which excludes volatile food and energy costs, also eased to 2.3% from 2.4% on a modest slowdown in services and industrial goods inflation.

The figures confirm economists' central narrative that the euro zone is entering 2026 on a solid footing even as it faces exceptional uncertainty.

U.S. tariffs have not yet fully fed through to prices and firms are still adjusting their value chains, suggesting that it could take much of 2026 for the picture to clear up.

GERMAN SPENDING TO THE RESCUE

"We are very conscious that the impact of the current tariff levels is still feeding through in the data and that US trade policy may still change, for example due to a Supreme Court ruling on the IEEPA tariffs or because of U.S. discontent about the existing deal," JPMorgan said in a note to clients.

Another issue is German fiscal stimulus. The government is boosting spending on defence and infrastructure and economists widely expect a boost to growth, but the start of the spending splurge is slow and it could still take time before it shows up in the numbers.

For now, the euro zone's biggest economy continues to skirt recession and its labour market is in the weakest shape in years.

Deutsche Bank expects a fiscal impulse worth 1.4% of GDP this year, boosting growth across Europe.

"The spillover benefits to the rest of the euro zone are a function of the composition of German fiscal spending, the degree of spare capacity in Germany and economic confidence outside Germany," it said in note.

Cheaper energy is also a boost since it reduces costs and improves the bloc's terms of trade given Europe's massive reliance on fossil fuel imports.

Still, overall economic growth could slow to around 1.2% this year from 1.4% in 2025, as the bloc is also facing a drag on multiple fronts.

Tariffs will keep on eating into exports, while China will continue to crowd out Europe from some of its key export markets. Industry keeps skirting recession on high costs, but the euro zone remains far too fragmented to produce at the sort of scale needed to compete globally.

The ECB, which supported the economy over the past two years with a steady stream of rate cuts, is also unlikely to do more.

Inflation is at target and dips below 2% are likely to be temporary, leaving the outlook rather balanced, especially in the medium term - the bank's relevant horizon.

This is why financial markets expect unchanged rates at each of the ECB's eight meeting this year and see some policy tightening next year.

"We expect rates to remain stable this year and continue to think further easing would require significant downside surprises, either on the growth or inflation front," Leo Barincou at Oxford Economics said.

(Reporting by Balazs Koranyi; Editing by Hugh Lawson)