Growth gears grinding in the eurozone

It sounds like a cliché, but each time optimism builds around a European growth acceleration, reality steps in. The political upheaval in France and the possibility of snap elections are set to prolong uncertainty in the eurozone’s second-largest economy, dampening short-term growth prospects.

Meanwhile, expectations of a substantial German fiscal boost driving eurozone momentum in the coming years require nuance. The German government is reallocating regular public investment from the budget to the infrastructure fund, which reduces the net fiscal impulse. While a stimulus will still materialise, its magnitude in 2026 is likely to be more modest. Moreover, the absence of meaningful structural reforms suggests that Germany’s fiscal plans will not permanently raise its potential growth.

Current data offer little hope of a breakout from the eurozone’s subdued growth trajectory. The contraction in German industrial output in both July and August points to a correction following the pre-tariff export surge to the US. Consumption remains tepid, with retail sales inching up just 0.1% in August after a 0.4% decline in July.

That said, consumer sentiment surveys hint at a marginal improvement in the coming quarters, and there are early signs of stabilisation in the construction sector. These indicators support the view of a weak but ongoing recovery, with a gradual acceleration expected in the second half of 2026. We maintain our GDP growth forecast of 1.3% for 2025, but revise our 2026 projection down to 1.0%.

September’s HICP inflation surprised slightly on the upside at 2.2%, but we do not expect this trend to persist. Underlying inflation, currently at a cruising speed of 2.3%, still has room to ease as wage growth moderates. Headline inflation is likely to dip below 2% again, driven by favourable base effects in energy prices – though these effects will peter out in the second half of 2026.

We now forecast average inflation at 2.1% in 2025 and 1.9% in 2026. Beyond that, inflation is unlikely to stay below 2% for long. The launch of the EU ETS2 system in 2027 will raise consumer energy costs, adding several tenths of a percentage point to headline inflation. Without a productivity surge, supply constraints could also re-emerge, pushing inflation higher in the coming years.

In this context, the ECB appears committed to a wait-and-see approach, with most board members favouring stable interest rates for the foreseeable future. We concur, although further rate cuts cannot be ruled out if the eurozone slips into recession or faces significant financial turbulence. A sharp appreciation of the euro could also prompt additional easing. According to the ECB’s September Staff projections, one risk scenario sees eurozone inflation at 1.5% in 2026 and 1.6% in 2027 if the EUR/USD exchange rate reaches 1.24 and 1.28, respectively.