Economists caution Europe to fix its issues or face a prolonged economic downturn.

• The euro zone concluded a tumultuous year, with Germany and France facing political and economic instability, leaving the region's two largest economies without a budget for this year.
• The absence of growth, fiscal imbalances, and political intransigence could lead to decline and a loss of standing for Europe as a whole, according to economists.

The euro zone's largest economies, Germany and France, have been facing political and economic instability, resulting in the absence of a budget for 2025.

The absence of growth, fiscal imbalances, and political intransigence could lead to decline and a loss of standing for Europe as a whole, according to economists.

According to Neil Shearing, group chief economist at Capital Economics, the current economic crisis in Europe differs from the earlier sovereign debt crisis in that the acute problems are no longer confined to smaller economies like Greece. Instead, it is Europe's two largest economies that are facing challenges.

"If Europe does not undergo fundamental reform, it will likely experience ongoing decline, with low growth, fiscal sustainability concerns, and a diminishing sense of global significance in a world marked by U.S.-China superpower rivalry, according to Shearing."

Amid political infighting, neither France nor Germany has a 2025 budget in place.

New elections are scheduled to occur in Germany in February, and experts predict that new parliamentary elections may take place in France in the summer. Currently, both countries are operating under provisional budgets, as they have rolled over their 2024 taxation and spending provisions into the present year. It remains uncertain when either country will reach a consensus on a 2025 budget.

Both overspending and underspending pose economic challenges for France and Germany.

The IMF predicts that France will have a budget deficit of 6.1% and a debt pile of 112% in 2024. The new government, led by Prime Minister Francois Bayrou, is expected to face challenges in passing a 2025 budget due to disagreements among deputies, as did his predecessor Michel Barnier.

In February, Germany will hold a snap federal election following the collapse of the governing coalition led by Chancellor Olaf Scholz due to disagreements over economic and budget policies. Germany's economic growth has been declining due to inadequate spending and investment.

Shearing of Capital Economics pointed out that while Germany's problem is excessively tight fiscal policy, it is in complete contrast to the situation in other countries.

Although the German public debt burden is low, the "debt brake" significantly limits the ability for deficit spending. A stagnant economy in Germany would benefit from looser fiscal policy, which would likely increase imports from other countries and support growth in France and Italy.

Need to focus on growth

Without budgetary plans, Europe's major economies will not be able to fully concentrate on policies promoting economic growth, exacerbating the recent trend of slow growth.

The combination of factors, including the conflict in Ukraine, rising energy costs, weakened demand from China and within Europe, and underlying structural issues such as low productivity and lack of competitiveness, has resulted in the impact on energy-intensive industries in Europe.

The European Central Bank has decreased its key rate to 3% in December, marking its fourth reduction this year, in an effort to stimulate economic activity in the euro zone. The central bank anticipates that the euro zone economy will achieve growth of 0.7% in 2024 and 1.1% in 2025. Inflation in the bloc is expected to be 2.4% in 2024 and 2.1% this year.

ECB President Christine Lagarde stated in a December press conference that economic growth risks are still pointing downward, and there is a possibility of increased tension in global trade, which could hinder the recovery of consumption and investment.

Peel Hunt's chief economist, Kallum Pickering, advised CNBC that the ECB should take a bolder approach and implement larger rate cuts in 2025.

Some argue that rate cuts won't solve structural issues, including low productivity growth, and potential tariffs on European imports to the U.S., which may be imposed by President-elect Trump.

According to Jari Stehn, chief Europe economist at Goldman Sachs, Europe will likely face a challenging economic year in 2025, with the investment bank projecting 0.8% growth for the euro zone, compared to 2.5% for the U.S., over the same period.

Despite the challenges, such as high energy prices, China's slowing economy, political uncertainty, and trade tensions, investors were still searching for positive opportunities in the region.

Stehn stated that there is speculation about whether Germany will receive additional fiscal support during future elections, although it is believed that some support may be provided, but it is expected to be limited.

"Some are questioning whether the European consumer will finally experience a positive surprise, despite a high saving rate and an abundance of funds available for spending. However, we believe there will be some support, but it's unlikely there will be a significant upside surprise."

Despite the challenges, Europe will grow next year because lower interest rates will aid in savings and consumer spending, according to Stehn.

"While we need to address the challenges we've discussed, such as energy prices and China, we must also acknowledge that lowering interest rates won't solve all of them," he stated.

"Ultimately, it's going to be a challenging environment."