The euro area economy remains resilient despite geopolitical and geoeconomic shifts and overall high uncertainty. The 4Q 2025 reading of 0.3% qoq GDP growth was a tad stronger than expected. January 2025 headline and core inflation came in at 1.7% and 2.2%, which is lower than ECB forecast. These data points are still largely within the broad outlines of our current base line scenario.
The good news for growth is early signs of economic rebound in Germany, with fiscal stimulus gradually kicking in, and industrial orders being the most recent piece of good news. The recent free trade agreements provide some further encouragement. The worrying issue is some tightening of lending standards for corporates. But more so that China’s growth remains export driven, its productive capacity is vast, and it will continue to export its domestic imbalances. The only sustainable solution to this is increased European productivity and elements of industrial policy to reduce our vulnerabilities and choke points such as rare earths.
We had expected headline inflation to slide below 2% early this year. Risks to inflation may still be largely balanced and importance of a single data point should not be exaggerated. With uncertainty remaining high, it is important to maintain data-dependent, meeting-by-meeting approach with full optionality. A broad set and flow of data must be followed, with particular attention over the coming months to NEIG inflation, wage dynamics, corporate profit margins and productivity developments.
As to exchange rate developments, over the recent months the euro/dollar rate has fluctuated in a relatively narrow corridor of 1.15 to 1.20, with the euro effective rate being quite flat. The last sizeable euro strengthening took place in 2Q 2025, which currently seems to be permanent. Given the lags, the peak effect of this past strengthening onto inflation is still to be seen later this spring and is “baked into” the baseline scenario forecast. The ECB Governing Council does not target any level of the exchange rate but a sizeable and pacey euro strengthening would lower inflation outlook via weakening competitiveness and economic activity, thereby potentially triggering a policy response.
Monetary policy remains in a good place and monetary policy is not where the action currently is. Urgent and decisive action is necessary in the area of structural reforms aiming to strengthen economic fundamentals to ensure continued improvement of our citizens’ living standards, strengthen resilience of our democracies and build Europe with a strong global standing in a geopolitically volatile multipolar world where we become a fully-fledged superpower and ourselves decide our future.