Our economic outlook for the euro area

The euro area has experienced a soft landing. Annual inflation is set to end 2025 close to the 2% target set by the European Central Bank (ECB) after peaking at above 10% in late 2022. Meanwhile, the economy is growing close to its potential and the unemployment rate is at its lowest sustained level since the creation of the euro in 1999. The ECB halted its easing cycle in June 2025, leaving the deposit facility rate at 2%, down from a peak of 4% in 2024. We expect it to stay at 2% throughout 2026.

Meanwhile, fiscal policy is taking center stage. Germany is now set to run annual budget deficits of close to 4% of GDP over the next decade. This will increase its debt-to-GDP ratio by between 20 and 30 percentage points. But with a current debt ratio of less than 65%, strong external fundamentals, and a solid track record of prudence, there is little concern over Germany’s medium-term fiscal health.

The same is not true for France. Investors have become concerned about France’s debt trajectory given projected budget deficits of 5% to 6% of GDP over the next few years, a debt-to-GDP ratio of 110%, and little political appetite to reduce spending. With the decision to freeze pension reform until 2027, we don’t see a clear path for fiscal consolidation in the near term. Expect political and fiscal uncertainty to pin back the French economy in 2026.