Our economic outlook for the euro area

Following the European Union’s recent trade agreement with the United States, we have revised our year-end forecast for the effective tariff rate on E.U. goods exports from 15% to 17%, which is higher than the current level of around 10%. While most U.S. tariffs on E.U. goods will increase, the deal reduces the risk of escalation. Given the modest scale of the revision, we do not expect a material impact on the macroeconomic outlook.

We continue to expect growth in the euro area to track around 1% in both 2025 and 2026, slightly below trend. GDP in the second quarter rose 0.1% quarter over quarter and signaled a reversal of the tariff frontrunning seen in the first quarter. We anticipate softening global activity and elevated policy uncertainty to weigh on demand in the second half of the year.

Germany’s fiscal package and increased E.U.-wide defense spending are likely to support growth from 2026 onward. Inflation continues to moderate, with the services index dropping to its lowest reading since early 2022 and wage growth falling meaningfully. We expect headline and core inflation to end 2026 below 2%. Given recent guidance from the European Central Bank, including remarks made at the July press conference that it is in a “good place” at the current policy rate level of 2%, we believe policymakers will keep rates steady at the September meeting. We forecast just one more rate cut this cycle, putting the policy rate at 1.75% at year-end, slightly below our estimate of the neutral rate (2%–2.5%).