Our economic outlook for the euro area

Despite the energy shock stemming from conflict in the Middle East, economic activity in the euro area has proved resilient. Growth is tracking above our 0.8% forecast for 2026, with strength that has been broad-based across major economies and driven by domestic demand.

That said, we see only modest pass-through of German fiscal stimulus in the industrial production data so far. Spending on military equipment has accelerated in the last year, but this is only a small part of total production. More prominent sectors that should be exposed to infrastructure-related spending—including construction, basic metals, and machinery and equipment—have yet to experience a material upswing.

Within the labor market, the euro area unemployment rate remains remarkably stable at 6.4%. However, the aggregate headline masks significant divergence under the hood. German employment growth is outright negative amid unfavorable demographics and a continuing industrial recession, while the French labor market is undergoing cyclical weakness. This contrasts with the strong growth story in Spain, where the rate of job creation is exceeding the immigration-led increase in labor supply.

Both crude oil and natural gas prices have moved higher in the past month. This, coupled with widening margins for refined fuel products, is raising the risks of second-round effects building into the system. We have increased our forecasts for core inflation to 2.5% for both 2026 and 2027, above the 2% target set by the European Central Bank (ECB).

The ECB announced a quarter-percentage-point increase of its policy interest rate to 2.5% on September 10, its second hike of 2026. Our forecast had called for just two ECB rate increases this year. However, given the higher energy prices and upward risks to inflation, we foresee an additional rate hike this year and another in 2027.