Euro zone economy grows 0.4% in first quarter, beating forecasts

The euro zone economy expanded by 0.4% in the first three months of 2025, according to flash estimates released by Eurostat on Wednesday, comfortably exceeding the 0.2% increase economists had pencilled in. The reading follows a revised 0.2% expansion in the final quarter of 2024 and suggests the currency bloc entered the year on a firmer footing than the business surveys had signalled.

Southern economies pull ahead again

The aggregate figure masks wide dispersion among the twenty member states. Spain and Lithuania each posted 0.6% quarterly growth, while Italy added 0.3%. Ireland's GDP surged 3.2%, a figure the statistics office itself treats with caution given the outsized role of multinational profit-shifting in the Irish national accounts. By contrast, Germany, the bloc's largest economy, managed only 0.2%, and France barely moved at 0.1%.

This north-south divide has become a recurring feature of the post-pandemic recovery. Southern member states have benefited from a tourism rebound, stronger domestic demand and, in some cases, faster absorption of EU recovery funds. Germany, meanwhile, has contended with persistent industrial weakness, high energy costs and the drag from a contracting construction sector.

Capital Economics sees a sharp slowdown ahead

Franziska Palmas, senior Europe economist at Capital Economics, described the print as evidence that the economy started 2025 on a stronger footing than activity surveys had suggested. She was quick to add a caveat. "Nevertheless, we still expect growth to slow sharply in the next six months as the US tariffs introduced in April will hit activity," Palmas said, noting that any boost from the large fiscal stimulus package currently being negotiated in Berlin would mostly be felt next year.

Her assessment aligns with the view from Frankfurt. The European Central Bank's March projections pencilled in 0.9% growth for the full year, a slight downgrade from the January forecast. Fresh staff projections are due in June, and policymakers have signalled those numbers will be pivotal for the next rate decision. The deposit facility rate was lowered to 2.25% earlier this month, down from a peak of 4% in mid-2023.

Lagarde signals policy caution amid trade shocks

Speaking on the sidelines of the IMF-World Bank spring meetings, ECB President Christine Lagarde acknowledged that the "disinflationary process is so much on track that we are nearing completion." Headline inflation stood at 2.2% in March, within touching distance of the 2% target. But she warned of "shocks that would dampen economic growth," a clear reference to the escalating trade conflict with Washington.

The European Union faces a 20% blanket tariff on exports to the United States, though the White House has temporarily reduced the measure until July to allow negotiations. Additional levies on steel, aluminium and automobiles remain in force. For its part, the EU has suspended its planned retaliatory tariffs while talks continue. The truce is fragile; neither side has indicated a willingness to concede core demands.

Sentiment deteriorates as uncertainty bites

Hard data may have surprised on the upside, but soft indicators are flashing red. Economic sentiment in the euro area fell in April to its lowest level since December 2024, according to the European Commission's monthly survey. The decline was broad-based, hitting industry, services and consumer confidence alike. Firms cite trade policy uncertainty, weakening order books and the rising cost of compliance with new regulations as the main drags.

Financial markets reacted calmly to the GDP print. The euro traded 0.08% lower against the dollar at 10:35 a.m. in London and 0.2% higher versus sterling. Germany's ten-year Bund yield, the benchmark for euro-area borrowing costs, slipped three basis points. The muted response suggests investors had already priced in a decent first quarter and are focused instead on the second-half trajectory.

German stimulus timing matters for 2026

Berlin's fiscal plans are the most significant domestic variable. The incoming coalition has agreed in principle to relax the constitutional debt brake and establish a 500 billion euro infrastructure fund, alongside higher defence spending. Legislative approval is expected before the summer recess. However, the transmission lag from legislative authorisation to real economic activity is substantial. Most analysts, including Palmas, see the impulse arriving in 2026 rather than this year.

That timing mismatch creates a policy dilemma for the ECB. If the central bank cuts rates further in response to near-term weakness, it risks over-stimulating an economy that will receive a large fiscal boost twelve months later. If it holds rates steady, it may be blamed for an avoidable slowdown. The June projections will be the first to incorporate the German package in any detail.

Trade negotiations face a July deadline

The US-EU tariff truce expires in July. Until then, both sides have agreed to negotiate. The EU is seeking a full exemption from the 20% blanket duty and the sectoral tariffs on metals and cars. Washington wants increased market access for agricultural products, changes to digital services taxes and commitments on defence procurement. Previous talks during the first Trump administration collapsed over similar issues.

A failure to reach a deal would reactivate the full tariff schedule and trigger EU countermeasures, likely targeting politically sensitive US exports such as bourbon, motorcycles and agricultural goods. The European Commission has prepared a target list but has not published it, preferring to keep pressure on the negotiating table.