Economic outlook

Uncertainty weighs heavy on growth

Europe faces a modest growth outlook in the short term, as uncertainty weighs on business investment and consumer confidence. GDP in the Eurozone is expected to increase by less than 0.9% in 2025 and by 1.1% in 2026.

The economic picture is mixed, however, with subdued overall growth masking divergent performances across the continent. European economies are shaped by differences in economic fundamentals such as sectoral mix and labour force characteristics, as well as fiscal constraints, and exposure to current geopolitical headwinds. 

Growth hotspots driven by resilience in domestic economies

Southern and Eastern European economies such as Spain and Poland are performing strongly, thanks to robust domestic demand, targeted investment, and solid labour market performance.

In contrast, many core economies continue to face structural and fiscal constraints that could limit their growth. Global trade tensions, monetary policy adjustments, and defence spending priorities will shape the path ahead.

Lower inflation provides space for most central banks to cut rates

Eurozone inflation is expected to ease further and average around 2.1% this year, down from 2.4% in 2024. Lower energy prices, weaker demand owing to global uncertainty, and increased competitiveness in domestic markets due to potential rerouted trade flows, are set to exert downward pressure on headline inflation.

We expect the European Central Bank (ECB) to cut rates in the second half of 2025 as inflation returns closer to its 2% target. Other major central banks are also expected to continue loosening of rates during this period, with the Bank of England expected to bring rates to 3.25% by the end of 2026 despite the recent spike in inflation.

Consumer demand takes lead role in driving growth

Declining interest rates should support a stronger pace of consumption growth across the continent. Stronger real wage growth continues to drive robust improvements in household incomes across most European countries, as the labour market remains supportive. But a large part of the growth in income has been channelled into higher savings, leading to a weaker pace of consumption growth in parts of Europe alongside steady increases in saving ratios.

And while robust growth in household disposable incomes could help support consumer spending, this might not fully counteract further headwinds arising from ongoing uncertainty on US trade policy.

Geopolitical pressures weigh on growth prospects

A number of manufacturing-oriented economies are facing headwinds from automotive tariffs imposed by the US. That’s especially true for especially the economies of Central and Eastern Europe, which are integrated into regional production chains. Alongside an ongoing downturn due to loss of competitiveness and elevated energy costs, this has led to a continuing weak growth outlook in Germany and Austria in 2025.

But our forecasts for 2026 have been revised upwards, partly due to the potential impact of higher defence and infrastructure spending in driving momentum in the manufacturing sectors in these countries.

While the direct impact of trade deals on the United Kingdom economy is likely to be small, and the US deal has the potential to ease some trade related uncertainty. In addition, supportive fiscal and monetary policies should contribute to a modest acceleration in consumer and investment growth this year.

Trade outlook offers a limited upside

New tariffs imposed by the US this year have worsened recent trends of escalating trade frictions. Changes in trade policy announced by the US have often been followed by short term reprieves, creating large swings in the applied rate of tariffs and amplifying the level of uncertainty for businesses.

In our upside scenario, where a trade deal is negotiated, the impact on economic growth in Europe is limited. But the relatively modest easing in tariff measures compared to the existing status quo and the high degree of uncertainty that exists in any scenario means the impact on GDP growth is likely to be small, with less than 0.1% uplift across Europe. A renewed escalation of tariff measures could cause significant damage to growth.

The trade deal with the US will result in the UK avoiding the direct impact of any escalation. But supply chain disruptions and a general economic downturn will be inevitable, which is likely to create an additional drag on economic growth.

Fiscal pressures will limit long-term increase in defence spending

Governments across Europe have announced plans to devote higher levels of funding to defence. However, a backdrop of relatively weak growth coupled with rising age-related spending commitments and the energy transition, may limit the extent to which governments can sustainably raise defence spending. We expect defence spending to settle at around 2.5% of GDP and increase by more than EUR700 billion over the next 5 years.