Etla forecasts: Finland's downturn is over - EU defence budgets may save euro area growth amidst tariff turbulence

Etla Economic Research's Economic Outlook Spring 2025 briefly:

• Finland's economy will grow by 1.2% this year. The economy started to grow already in the middle of last year, but growth has so far remained slow. GDP will grow by 1.4% in the next year and 1.2% in 2027.
• Both private and public investment will increase this year. Private consumption will also pick up slightly after two weak years. However, adjustment measures are holding back public consumption growth. Next year, household consumption growth will strengthen. Investment will remain on the rise, but public consumption will slow down.
• International demand is recovering, but net exports will contribute negatively to GDP growth.
• The unemployment rate will fall to 8.2% this year and 7.9% next year. The employment rate will rise with economic growth from this year onwards.
• Inflation will remain low this year but will normalise to 1.8% in 2027.
• The government deficit-to-GDP ratio will not fall below 3% until 2027, when the debt ratio will approach 87%.
• Risks to this projection are related to economic and geopolitical uncertainty and an increase in inflation. German infrastructure investment and European defence spending could have a positive impact.

 

Tariffs as a threat to international trade

The uncertainty created by President Donald Trump's proposed tariffs is casting a shadow over the prospects for international trade. Despite the tariff turbulence, the US economy remains on a stronger growth path than the euro area. However, inflation is persistent in the US and the Fed will not be able to cut interest rates as much as the ECB in the euro area.

Growing economic and geopolitical uncertainty is also weighing on the euro area and Finland's net exports are not bouncing back. The main risk in Etla's economic forecast is the impact of tariffs and counter-tariffs between the US and the EU, says Päivi Puonti, Head of Forecasting at Etla Economic Research.

— The risk is that tariffs and economic policy uncertainty in general will reduce trade between the US and the EU and slow growth on both sides of the Atlantic. Of course, what ultimately happens will also depend on the negotiating power of the European Commission. What is clear, however, is that the tariffs will slow down US economic growth already this year, says Puonti.

Etla Economic Research estimated earlier this week that Finland's GDP would fall by 0.5-1.6% if the US increased tariffs on all products to 25 per cent. So far, the US has imposed only 25% steel and aluminium tariffs on the EU. Puonti believes that the most pessimistic scenario, in which GDP growth in both Finland and the euro area fall to zero is still avoidable.

— Europe's internal demand could still rescue euro area growth if tariffs reduce Europe's external demand. Planned debt-driven increases in defence and infrastructure investment by Europe's largest countries, especially in Germany, will offset potential export losses. Tariffs would also likely result in a redirection of international trade flows.

Public spending increases would benefit construction and industry not only in Europe, but also in Finland. The spending increases could trigger many of the green investments planned in Finland. However, a real growth spurt would require a boost in demand for European products, and hence in production.

Finland's economic growth still sluggish, bold action needed

The weak business cycle in 2023-2024 is explained by a two-year investment slowdown. Slow economic growth in Finland will continue in the coming years. Etla forecasts GDP growth of 1.2% this year and 1.4% next year.

— Everyone knows the economy is growing too slowly - the problems lie in the private market sector. We are taking a substantial risk if we now assume that aggregate productivity will start to grow sufficiently just by waiting. Waiting is in fact a greater risk than being "too bold". Reforms need to be implemented, and tax incentives should be included in the reform package to get growth going fast enough, says Aki Kangasharju, CEO of Etla.

This year public investment in Finland is growing when the Defence Forces’ new fighter jets are expected to start arriving at the end of the year. The government will also invest in R&D and road maintenance. Private investment and consumption demand is slowly picking up and the construction sector is already turning the corner, with interest rates falling and purchasing power improving. Investment in machinery and equipment is also showing a cautious upturn.

Growth in public consumption expenditure will be restrained by government adjustment measures, which will continue until 2027. It is noteworthy that in recent years, public spending has settled at a permanently higher level than in the past," says Päivi Puonti, Head of Forecasting at Etla.

— There is a de facto gap between public expenditure and revenue, and the problem lies precisely on the expenditure side. Since 2007, expenditure has risen to a permanently higher level relative to the size of the economy, and tax increases will not close that gap.

The government's employment measures are helping the labour market

Employment and unemployment developments have partly diverged from the normal business cycle, for example, with unemployment rising more than would be expected given the cyclical situation. However, labour force growth will improve employment prospects in the future as labour becomes available when the economy starts to grow. Employment growth is also supported by the government's employment policies.

The unemployment rate will fall to 8.2% this year and below 8% in 2026. The employment rate has remained above its pre-pandemic level, rising to almost 77% this year.

Inflation on the rise to a “normal level”

Inflation will accelerate as the year progresses, and Etla forecasts it will on average be just under 1% this year, which is clearly lower than last year. The slowdown in inflation is driven by lower interest rates. On the other hand, health care costs and food prices have been on the rise. Much of the latter is due to higher coffee and chocolate prices. Next year, consumer prices will rise by an average of 1.6%. EU-harmonised inflation, from which interest rates in particular have been removed, will be close to 2% in the forecast years.

Households' purchasing power will continue to improve, but consumption will remain frail, and the savings rate will increase slightly further this year. As household consumption accounts for almost half of Finland's GDP, households' consumption behaviour strongly influences the direction of the economy.

Finland's public expenditure as a share of the total economy reached a record high of almost 58% last year. This year, the general government deficit will remain around 4% of GDP and will not fall below the 3% threshold until 2027. By then, the debt-to-GDP ratio will approach 87%.

The online version of Etla’s Economic Forecast “Suhdanne” (in Finnish) is available for reading and downloading at www.etla.fi. All graphs and tables in the online version can also be downloaded separately at www.suhdanne.fi. A PDF version (in Finnish) can be downloaded at www.etla.fi/publications.

Annexes: Figure 1: Public expenditure and revenue in relation to the size of the economy, Figure 2: GDP and its expenditure components 3. Some key forecasts.