Our economic outlook for the euro area

The growth outlook in 2026 will be shaped by two opposing dynamics. The first is the headwind from higher U.S. tariffs, which we expect to reduce GDP by 0.3 percentage points. The second is looser fiscal policy, led by Germany’s infrastructure package and greater defense spending throughout the European Union (E.U.). We estimate that Germany’s fiscal loosening will boost German GDP by 0.5 percentage points in 2026 and euro area GDP by 0.2 points. We anticipate a further 0.2-point lift to euro area GDP from increased defense spending by other E.U. nations.

German industry has been in consistent decline for several years, but we are finally observing signs that activity has bottomed out. New orders have accelerated, partly driven by defense-related sectors. We continue to expect euro area growth of 1.2% in 2026, but risks now skew to the upside given the upturn in German activity.

We foresee the European Central Bank policy rate staying at 2% through 2026. That’s our assessment of neutral, or the rate that would neither stimulate nor restrict economic activity. But we judge risks as skewed toward further easing given the strength of the euro, moderating wage growth, and the prospect of inexpensive Chinese exports being rerouted to Europe.