Mission Concluding Statement 

Euro Area: IMF Staff Concluding Statement of the 2024 Mission on Common Policies for Member Countries

June 20, 2024

Following the pandemic, Russia’s gas shut-off, and fallout from the war in Ukraine, the euro area economy is gradually recovering, and inflation is declining towards target. Banks have proven resilient to the sharp rise in interest rates. Borrowing rates of sovereigns have remained moderate despite high public debt. Despite these reassuring signs, significant challenges remain. Fiscal buffers have diminished while spending pressures are set to increase further. Population aging and sluggish productivity growth weigh on the medium-term outlook. Intensifying geopolitical tensions, trade disputes, and distortive industrial policy can further complicate economic prospects and the policy making environment for a region highly open to trade. These challenges call for well-calibrated macroeconomic stabilization policies and structural reforms to strengthen the EU architecture and the single market. Such policies can reinforce each other to lift growth, enhance resilience, and address challenges from an increasingly shock-prone and fragmented global economy. 

Outlook and risks

A modest growth pickup is projected for 2024—strengthening further in 2025—but the medium-term outlook remains challenging. Euro area growth is picking up, albeit from a low rate. In 2024, increasing real wages and some drawdown of household savings are expected to contribute to a consumption-led recovery. In 2025, easing financing conditions are projected to support a recovery in investment, while healthy employment and nominal wage growth continue to support consumption. In the medium term, however, growth is expected to be held down by population aging and low productivity growth.

Inflation is projected to return to target in the second half of 2025. The 2022–23 monetary policy tightening is helping to bring down inflation and will continue to do so for some time to come. Past declines in commodity prices are also contributing to the reduction in headline inflation. Services inflation—which is more sensitive to wage increases—is also declining, though more slowly than headline inflation. Recent wage growth and inflation data have registered a slight pickup in annual terms, reflecting, in part, one-off factors. Nonetheless, the broad set of wage trackers and measures of underlying inflation point to deceleration ahead as nominal wage growth moderates from its high levels seen in 2023 and corporate profit shares compress.

Risks to growth are on the downside while they are two-sided for inflation. Past monetary policy tightening could put a stronger drag on output than expected. Growth can also be lower due to adverse external developments, such as intensifying geopolitical tensions and/or weaker global demand. Moreover, consumption growth may not pick up as envisaged if labor markets cool, hurting consumer sentiment. These factors could also drag inflation below the baseline. They counterbalance upside inflation risks from stronger-than-expected wage pressures or profits margins failing to compress as anticipated, as well as renewed commodity price spikes or shipping disruptions.

Ensuring macroeconomic stability

The ECB can gradually loosen its monetary policy stance, at a pace that depends on incoming data. The projected disinflation path and balanced risks around it—based on current information—imply that interest rates can be gradually lowered to reach a neutral stance—consistent with a terminal policy rate of around 2.5 percent—by the end of the third quarter of 2025. Continued, gradual monetary easing would achieve a balance between keeping inflation expectations anchored and avoiding an overly restrictive policy stance. The inflation outlook may change over time as more information becomes available, in turn changing the appropriate course of the policy rate. Ultimately, decisions on the policy rate will have to be taken meeting-by-meeting based on incoming information.

The new EU economic governance framework will require significant fiscal adjustment in many member states as well as sustained political support to be implemented as envisioned. The new framework identifies long-term fiscal sustainability risks and requires country-specific medium-term adjustment that is sufficiently ambitious to address those risks. While significant fiscal adjustment will be needed in many high-debt and high-deficit member states, those with moderate or low fiscal risks will have more room for fiscal support if needed. The medium-term fiscal-structural plans due in September 2024, should be underpinned by a clear fiscal strategy, growth- and resilience-enhancing structural reforms, and high-quality measures. The cumulative fiscal adjustment called for by the new fiscal rules appears appropriate and should be implemented as envisioned. In high-debt countries where output gaps are small and measures with low fiscal multipliers are available, more front-loaded fiscal adjustment than the framework’s default linear annual adjustment path would demonstrate resolve, support market confidence, and create room for future expenditure surprises.

Policymakers should continue to safeguard euro area financial stability and expand the macroprudential toolkit. Banks have been resilient in the face of a rapid rise in interest rates. Their capital ratios in aggregate are strong and liquidity is ample. Bank profits are high but will likely moderate. Therefore, even though credit growth is currently low, the authorities should encourage banks to use their temporarily high profits to build safeguards, including by increasing countercyclical capital buffers requirements. These can later be released as needed to support credit provision if risks materialize in a severe downturn. Ad-hoc taxes on bank profits are problematic because they create an uncertain business environment, and they could also impede bank capital accumulation. Policymakers should develop nonbank macroprudential tools, such as restrictions on leverage or emergency curbs on redemptions for investment funds, while continuing efforts to bridge data gaps and improve data sharing among supervisors.

Boosting productivity, achieving climate goals, and addressing fragmentation

Higher growth would create policy space to tackle the fiscal challenges of aging, the green transition, energy security, and defense. Europe’s economy is hamstrung by low productivity growth, which will be increasingly problematic for the growth of living standards as adverse demographic trends intensify. Insufficient private and public investment, low R&D expenditure in digital technologies, administrative barriers to entry of firms and rigid labor markets are all contributing factors. Actions by member states to strengthen implementation capacity for reforms and investments would help speed NGEU disbursement, supporting growth and productivity. Further integrating financial markets, enhancing the EU budget for public goods investment to address shared long-term challenges, increasing labor market flexibility, and strengthening the single market while avoiding distortive industrial and trade policies would all help promote an efficient allocation of resources, achieving productivity gains and fostering inclusive and sustainable growth.

Without further financial market integration and deepening, Europe will not only fall short of its transformative goals of energy security, climate change mitigation, and digital transition but also risk falling behind global peers. In a time of geoeconomic fragmentation and rapid structural change, Europe’s economic prospects rely on revitalizing productivity growth and attracting the investments needed to accelerate the green and digital transitions. Integrating fragmented national capital markets in a capital markets union would help advance these goals by boosting finance for innovative long-term investment projects, increasing risk-sharing opportunities, enhancing the allocation of savings in the EU, and reaping EU-wide economies of scale in financial markets. An integrated capital market would benefit from strengthening ESMA’s ability to coordinate across national authorities and a greater harmonization of financial markets oversight, as well as ambitious steps by member states to further the convergence of insolvency, taxation, accounting, and legal frameworks. This can be achieved for instance through a “28th regime” for corporate law to which firms in the EU could opt in. Initiatives to further the banking union—including those aimed at strengthening the crisis management toolkit and introducing European deposit insurance—and the ratification of the ESM treaty to operationalize the backstop for the Single Resolution Fund should be given priority.

The EU budget needs to be enhanced to lift and better target public investment. The next Multiannual Financial Framework offers an opportunity to emphasize investment in EU public goods (including on energy security, climate change mitigation, defense, R&D) to address the large structural challenges that confront the economy. For instance, a Climate and Energy Security Facility (CESF)—with the objective to advance on climate and energy security goals—can address shared long-term challenges in an effective and coordinated manner. The CESF would help achieve EU emissions reductions goals in a more cost-effective way and facilitate investments in cross-border energy infrastructure, R&D, and public support for clean-tech sectors.

Labor market policies at both national and EU levels should aim to enhance skills, ease labor reallocation, and counter the effects of a shrinking workforce. Reskilling and upskilling programs, apprenticeships, unemployment benefit reforms, incentives for a longer career, and support for female labor force participation can help mitigate the impact of aging on aggregate labor input. Fostering mobility across the EU, through faster recognition of professional qualifications, more portable pension and social security benefits, and greater labor market flexibility, can help balance labor demand and supply. Better integration of migrants into labor markets will support labor supply and help address labor shortages.

The EU should prioritize strengthening the single market while avoiding distortive industrial and trade policies. Measures aimed at protecting the EU’s economic resilience and competitiveness in response to the fragmentation of international trade and the threat of protectionism, should avoid creating distortions that may hurt Europe’s economy and provoke tit-for-tat retaliation by trading partners elsewhere. Staff analysis finds that national-level state aid improves recipient firms’ outcomes, but it also entails significant negative spillovers to nonrecipient firms, which could weaken the single market. Where state aid may be justified in response to market failures, its judicious and temporary use should be limited in scope and coordinated at the EU level to preserve a level playing field. The EU should continue to promote efforts to strengthen the rules-based international system.

Policy must internalize the fiscal, efficiency, distributional, and cross-border effects of the EU’s climate goals. Achieving the EU’s emissions reductions targets requires significant private and public investment. Reduced fossil-fuel dependence and increased energy efficiency can strengthen Europe’s competitiveness over the medium term, but the adjustment costs could hurt it in the short term. The EU green industrial policies should avoid contributing to a wasteful subsidy race. Although the CBAM can help avoid “carbon leakage”, its design must ensure low administrative costs and the EU should continue to engage with its trading partners to ensure that it is implemented consistently with WTO rules. Care should be taken to avoid disproportionate economic costs on trade partners. Given its distributional implications, climate action needs to be accompanied by measures to offset costs for vulnerable households in the EU.