Europe stock market outlook 2025: looking over the cliff edge

Political uncertainty hangs over Europe. In particular, government divisions threaten economic progress in the two main drivers of the European Union - Germany and France.

Germany has been in growing political difficulties since Angela Merkel stepped down as chancellor in 2021. She led the Christian Democratic Union (CDU), the political party that has dominated German, and previously West German, politics for most of the past 75 years.

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Olaf Scholz has been balancing a three-party coalition, known as the “traffic light” coalition from the colours of its respective partners, the Social Democrats (SDP), the Free Democratic Party (FDP) and the Greens. Elections were not due to be held until next September and could be brought forward only through a vote of no confidence in the chancellor, which has now happened.

Federal government in Germany has been in a state of crisis for months as the coalition partners, with different agendas, fought each other but did not dare to provoke an election where they all stood to lose seats in the Bundestag. 

Policymaking has been deadlocked on major issues to the point that the FDP published its own unilateral manifesto aimed at reviving the country’s economic stagnation. Scholz promptly sacked FDP leader Christian Lindner as finance minister, prompting a further political crisis.

Meanwhile, the opposition CDU threatened to bring the Bundestag to a standstill by rejecting its daily order of business.

Germany, so long the powerhouse of the European Union with factories in eastern Europe dragging up the former Soviet Union satellites, has drifted into economic stagnation. The over-dependence on a few industries such as vehicles and chemicals, plus a reliance on Russia for gas supplies, left the nation vulnerable. For the past couple of years, the economy has been flirting with recession, a situation that economists believe will continue.

There are serious concerns that the country is being left behind in the digital age of computers, smartphones and electric cars. It has a poor mobile phone network, fax machines still proliferate and many shops are unable or unwilling to accept credit card payments.

These issues are likely to be exacerbated by any tariff measures taken by new US President Donald Trump, since Germany has a substantial trade surplus with the US.

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France, like Germany, has evolved into a state of political stasis, but a possible solution via a general election cannot be resolved under the French constitution until June at the earliest. Like the United States, France elects its president and legislature separately, although these elections do not necessarily coincide as they do in the US, and the legislature does not always sit for a specific number of years.

President Emmanuel Macron called early parliamentary elections last summer in the hope of strengthening his presidency. Alas, his centrist party lost ground and the big gains were made by far right and far left parties who do not want to govern together, but between them had enough seats to topple the minority government under Michel Barnier installed by Macron in September.

National Rally, the far right party led by Marine Le Pen, is the largest single party with 124 MPs. She withdrew her passive support for the government in November, threatening to join the 192 MPs belonging to various left-wing parties, in voting against the Budget. The left-wing bloc is the largest grouping in parliament, and its MPs feel they should have been asked by the president to form a government and were therefore hellbent on bringing down the one installed by Macron.

At the heart of the crisis is a ballooning French government deficit running at just over 6% of gross domestic product, double the 3% limit set by the European Commission. Brussels is not willing to make any concessions that would damage the euro, especially as Italy, Spain, Portugal and Greece have at various times accepted the need for austerity measures.

EU officials fear that unless France curbs its Budget deficit, then the cost of servicing the country’s debt will balloon and that other EU countries will suffer financial contagion. The European Central Bank (ECB) will find it politically impossible to buy up French government bonds unless austerity measures are put in place.

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Prime Minster Barnier, formerly the European Union’s chief Brexit negotiator, wanted to avoid seeing the Budget deficit ballooning next year to 7% of GDP, which would make it the highest in the European Union and would mark the third consecutive year of budget deficits way above the permitted norm. Barnier wanted to make cuts in government spending, plus tax increases, worth a combined €60 billion. Even with such measures, which were deemed unacceptable to most political parties in France, the deficit would still be 5% of GDP.

Realising he would be unable to force the budget through the French parliament despite making some concessions, Barnier attempted to use a procedural means of avoiding a vote, prompting a motion of no confidence, which the government had no hope of winning.

When the inevitable happened, Macron was left facing the unpalatable choice between caving in to rival parties that could put together a government, ask Barnier to try again, or find a new supportive prime minister who would face exactly the same problems.

Barnier agreed to continue in a caretaker role. He may try to cling on until the outcome in January of a trial accusing Le Pen and 24 associates of illegally syphoning off €4 million of European parliamentary funds to finance her party. If found guilty, Le Pen could be barred from public office.

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However you look at it, the situation in France is a mess. It is likely to continue through at least the first half of the new year with a minority government just when it needs a strong hand to tackle the country’s financial woes.

With the two largest European economies looking over the cliff edge, the gap between Europe and the United States is likely to widen in 2025. This is reflected in the fact that while the S&P 500 shares index has gained about 9% over the past three months, the Stoxx 600, the nearest European equivalent, has slipped 2%.

According to the International Monetary Fund (IMF), the gap between income per capita in the EU and the US has grown to 30% over the past decade. The gap widened significantly after the 2008 financial crisis and is set to grow wider next year, the IMF says. US President-elect Donald Trump’s threat to impose tariffs on Europe’s $600 billion-a-year exports to the US will hardly help to close the gap. As well as France and Germany, Italy will suffer particularly from any tariff barriers. These three countries are heavily dependent on trade.

The ECB has indicated that it intends to continue the monetary easing it began in June, with further interest rate cuts on the cards. This will make European assets less attractive and push down the value of the euro.

Hobson’s choice: Investors may prefer to look away from the stagnating giants of yesteryear and look for growing younger companies that look to have a real future. For once, solid and boring does not look to be the way to financial security.

Rodney Hobson is a freelance contributor and not a direct employee of interactive investor.