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ItaliaFurther economic recovery thanks to the ECB’s looser monetary policy
Luxembourg's economy showed a moderate recovery in 2024 after the recession-intermezzo of 2023. It is highly dependent on the financial services sector, which represents roughly 30% of the GDP. The country is the world's second-largest investment fund centre (EUR 5.5 trillion in assets under management in May 2024) behind the US. The tightening of the ECB’s monetary policy between July 2022 and September 2023, together with the very high level of interest rates (4% for the deposit rate at the peak) had abruptly slowed economic momentum in Luxembourg. In the course of 2024, however, the key interest rate (deposit rate) was reduced three times by 25 basis points each until the end of October. A further interest rate cut of this size is expected in December. The trend has somewhat spurred activity in the financial sector again. Further interest rate cuts are expected in 2025, down to a “neutral” level of 2-2.5%. This interest level should neither slow down nor bolster the European economy. At the same time, however, the ECB is also continuing to reduce its balance sheet total. From the beginning of 2025, the PEPP (Pandemic Emergency Purchase Programme) will no longer be reinvested (even in part), which could have an opposite impact on bond interest rates. Nevertheless, the slow normalisation of monetary policy should continue to boost the financial sector and contribute to strong economic growth in 2025.
On the demand side, the economic upturn in 2025 will be supported by private consumption. Purchasing power is generally quite high in Luxembourg thanks to the automatic adjustment of wages (and pensions) in line with inflation. In 2022 and 2023, this adjustment contributed to robust consumption compared to its European neighbours. In 2024, the inflation rate more than halved over the course of the year, falling below the ECB's inflation target of 2% in August. It is expected to remain in this range until the end of the year, postponing the need for wage adjustments. The main reason for this was the fall in energy prices. Moreover, an energy price cap was still in place in Luxembourg in 2024, which kept household electricity bills artificially low. The measure will be withdrawn at the beginning of 2025, which, according to estimates by utility companies, will cause electricity bills to shoot up by 30%, which, in turn, will drive up inflation and push it back above 2%. This should correspondingly lead to an automatic wage adjustment in Spring 2025. Some state support to pay electricity bills will continue, especially for families in need. Electricity put aside, the generally optimistic outlook for 2025 should lift consumer sentiment. The same applies to private investment, which should benefit from the lower interest rate environment.
Foreign demand, at least from the main trading partners should change little (France, Germany and Belgium account for 54% of goods exports). Although Germany could finally see some economic growth, growth momentum in France and Belgium could slow slightly.
Slight public deficit and strong current account surplus
The public account should remain in slight deficit in 2025 and will decrease somewhat. While the energy price cap will terminate at the end of 2024, another wage adjustment in the public sector and for pensions will not be completely offset by higher tax revenues and lower expenditures elsewhere. Luxembourg’s public debt will remain one of the lowest in the eurozone, i.e., below the 30% of GDP threshold, which was the political target set by a 2018 government agreement.
The current account surplus surged in 2024. The improvement came entirely from the balance in trade of goods and services. While exports declined markedly, imports even went down further. The balance of goods trade went into a surplus and the substantial services surplus (33% of GDP in 2023), which is mainly attributable to banking and financial services, increased. However, some of these gains were levelled out by the increase in the large deficit in the balance of primary income caused by the repatriation of dividends from massive portfolio investments made in the country (26% of GDP). For 2025, the trade in goods balance is expected to normalise, especially as inflation is easing. This will result in a lower balance of trade account. On the other hand, the deficit of the primary income balance should stabilise as well. Together, this should sum up to a durably strong current account surplus, albeit one that is lower than in 2024.
Government turns centre-right again
Prime Minister Luc Frieden, from the Christian Social People’s Party (CSV) is leading a government coalition together with the liberal Democratic Party (DP) which has held 14 seats in Parliament since the last general election in October 2023. The CSV, traditionally the strongest party in Luxembourg, garnered 21 out of 60 seats. However, over the last ten years, the CSV's dominance has waned, allowing the smaller DP to form a governing coalition with the support of the Social-democratic LSAP (which still holds 12 seats) and the green DG (with 4 seats in the current Parliament) in the previous legislature. As the Greens lost support in Luxembourg (as in other European countries) in 2023, the coalition was no longer viable. Former Prime Minister Xavier Bettel of the DP therefore changed his alliance and is now continuing to govern as a junior coalition partner in the new government. Overall, the political programmes of both parties fit together well, and their cooperation has been tested. There have been 5 CSV-DP coalitions since the end of World War II, with a total of 19 government cabinets.
The new government has taken up the cause of “a strong economy, a responsible and efficient welfare state, and a pragmatic ecology”. Concretely, the government plans to make private complementary pensions more attractive. The state pension scheme is unsustainable as by 2027 it should be paying out more than it receives. Pensions are automatically indexed to inflation. However, it is unlikely that this scheme will be changed soon. Due to a lack of housing, real estate prices increased strongly. The coalition, therefore, plans to introduce some tax cuts (e.g., for capital gains on investments in rental properties or tax credits for first-time buyers). This would be compensated by higher taxes. To comply with a global agreement reached at the OECD, Parliament passed a law which requires multi-national companies with revenues above EUR 750 million to pay a minimum corporate tax of 15%. In the past, some exemptions were given, allowing a tax rate of only 1% to attract firms. Most of these measures are, however, only in the planning stage.
In general, the political system in Luxembourg is very stable, therefore the coalition should pursue its work for the full five-year term until the next general elections in 2028.
