EY European Economic Outlook

European Economic Outlook: Growth Gradually Accelerates Despite Tariff Headwinds 

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5 minute read 03 Mar 2026
Related topics
Economics
Geostrategy
Transformation

Europe enters 2026 with a cautiously improving growth backdrop—but the outlook remains marked by elevated uncertainty. Trade policy, geopolitics, fiscal dynamics, demographics, and productivity trends are all interacting in ways that can meaningfully shift the growth and inflation path.

Underlying activity in the euro area continues to gradually strengthen, even as US tariffs weigh on growth. However, headline GDP growth is projected to slow to 1.3% in 2026 (from 1.5% in 2025), largely due to a normalization in Ireland after an outsized 2025 boost. Inflation, meanwhile, should stabilize near 2%, and the ECB is expected to keep the deposit rate at 2%.

Key forecast drivers

Tariffs: a manageable shock, but still a drag.

US trade policy remains a key external headwind in 2026. Following the Supreme Court’s invalidation of IEEPA-based tariffs, the administration has shifted to Section 122 of the Trade Act to impose a 10% baseline tariff on all trading partners, with plans to raise the rate to 15% in the near term. Although Section 122 measures can remain in place for only up to 150 days without Congressional approval, our base case assumes that comparable measures will continue thereafter—most likely through Sections 301 and 232. Importantly, the ruling does not affect existing non-IEEPA tariffs, including those on cars, steel, and aluminum.

Bottom line for Europe: while the Supreme Court’s verdict is material for China, it changes little for the EU, as the baseline rate remains at 15%. Even though the growth impact in 2025 looked limited, we estimate tariffs will shave 0.5 pp off EU’s GDP growth in 2026, with the most negative effects concentrated in Ireland and Nordic countries.

In this edition of the outlook, we also examine the recently announced EU-India Free Trade Agreement. While the aggregate macro impact on Europe is negligible, sectoral effects are somewhat more meaningful. For example, minerals sector may benefit from improved access to production inputs, while clothing industry could face stronger competitive pressure from Indian producers.

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Geopolitics: contained impact so far.

 

The recent escalation of the conflict in Iran underscores that geopolitics remains one of the major factors shaping the economic outlook. While the current conflict has substantial impact on the Middle East, its global economic repercussions are likely to be limited – we estimate that a temporary increase in energy prices, weaker business and consumer sentiment, and some trade disruptions could raise euro area inflation by 0.3 pp in 2026 and reduce GDP by 0.2%. However, the situation remains fluid, and further escalation could lead to more severe consequences. If the Strait of Hormuz is blocked, triggering a persistent surge in energy prices, euro area GDP could be about 1.3% lower by 2027 relative to a no-escalation scenario, while HICP inflation could rise to around 5%. 

 

Fiscal and monetary policy will provide a limited offset to the drag from tariffs.

 

Germany’s fiscal stimulus is starting to filter through, visible in improving industrial orders. That said, implementation is likely to be gradual and more delayed than planned. We still see the peak impact on growth occurring next year at +0.8 pp in Germany and +0.3 pp at the euro area level. Some spillovers should lift growth modestly in CEE, Austria, and the Netherlands.

At the euro area level, fiscal policy is expected to be broadly neutral in 2026, as easing in Germany, the Netherlands, and Nordics is broadly offset by tightening in France, Italy, and Romania. At the same time, past monetary policy easing continues to support activity, adding around 0.2 pp to euro area growth in 2026.

 

Demographics are a rising constraint on Europe’s potential growth.

 

Over the next 4 years, euro area labor supply is expected to rise only marginally, reflecting a stagnant working-age population and only a modest increase in labor force participation.

Cross-country divergence is striking:

  • Labor supply is still expanding in Ireland, the Nordics, Spain, the Netherlands, the UK, and Switzerland, largely due to immigration.
  • Germany, Greece, and most CEE countries face declining labor supply due to decreasing working-age population, which won’t be fully offset by increasing labor force participation.

Over the longer term, European economies increasingly confront demographic pressures—though the severity differs—characterized by declining working-age populations and limited remaining room for further gains in participation. Consequently, labor supply becomes a persistent drag on trend growth. The pressure is most acute in CEE and Southern Europe.

 

Productivity and AI: the opportunity Europe can’t afford to miss.

 

Given tightening labor supply, productivity becomes the decisive lever. Investment in productivity-enhancing technologies, especially AI, will be critical. Our analysis suggests AI could raise Western Europe’s GDP by up to 4% by 2033. Yet current indicators do not point to an AI investment boom comparable to the US. In that sense, Europe risks losing momentum in the AI race before it fully begins.

Investment in AI-related technologies and AI adoption rates also vary widely across Europe, with Nordic and Benelux economies leading the way, while CEE (notably Poland), Germany, and Italy are lagging. 

Activity trends: Underlying growth is improving, even as headline numbers distort

Euro area growth has been distorted by Ireland’s outsized contribution. Excluding Ireland, the underlying pace of real GDP growth has been gradually strengthening despite tariffs: to 0.3% q/q in 2025 Q3 and 0.4% in Q4, as investment and exports began to recover.

In 2025, euro area GDP rose 1.5%, inflated by a staggering 13.3% increase in Ireland, largely linked to tariff frontloading effects. Ex-Ireland, underlying growth reached 1.0%, up from 0.8% in 2024.

The structure of growth is shifting:

  • Government spending and private consumption slowed as tariffs weighed on consumer sentiment.
  • Exports resumed growth, but still lag world trade amid euro appreciation and competitiveness challenges (including pressure from China).
  • Manufacturing has returned to stagnation after an early-2025 uptick driven by tariff frontloading.
  • Services continue to expand moderately, led by ICT.

While cross-country disparities persist, growth in laggard economies, including Germany, seems to be picking up.

  • Ireland still shows strong momentum even on alternative activity measures (e.g., modified final domestic demand), with 2025 Q4 growth exceeding 4% y/y.
  • Poland remains among the strongest in Europe at 3.6% GDP growth in 2025 Q4, supported by real income gains, expansionary fiscal policy, and NextGenEU spending.
  • Spain continues to grow strongly (2.6% y/y in 2025 Q4), benefiting from a booming tourism sector, NextGenEU, and robust immigration.
  • Other relatively solid performers include Bulgaria, Czechia, and Croatia in CEE, alongside Greece and Portugal in Southern Europe.
  • Denmark’s growth remains robust but volatile (pharma-driven). Sweden and Norway are in cyclical recovery, supported by lower interest rates.
  • The Netherlands remained one of the stronger performers among Western European economies, expanding at a steady 1.7% y/y, supported by fiscal expansion and robust exports.
  • France saw growth pick up in the second half of 2025 but at 1.1% y/y it still lagged the euro area average, as ongoing political uncertainty continued to weigh on economic activity.
  • Among slow growers—Germany, Italy, Switzerland, Austria, Finland, Hungary, Slovakia— recent data suggest that the trough may be behind them, even if the industrial base remains under pressure. Romania stands out as stagnant due to fiscal tightening and energy price hikes.

Labor market: stabilizing, cooling at the margin

Euro area employment growth is steady at 0.7% y/y (driven largely by Spain). Nominal wage growth is stable around 4% y/y. Yet the labor market is still cooling: vacancy rates continue to decline and fewer firms report labor hoarding. This can be explained by normalization in labor demand after past negative supply shocks, pandemic-era distortions, and labor hoarding. AI may also be contributing to softer labor demand, with early indications of a correlation between AI adoption and youth unemployment across countries.

Despite some labor market cooling, unemployment remains near historical lows in the euro area: continued declines in Spain and Italy have offset modest increases in Germany and France. Substantial cross-country differences in labor market slack persist, featuring looser conditions in Southern Europe and the Nordics, and tighter in many CEE economies. This, alongside differences in inflation as well as minimum wage and public sector wage policies, feeds into meaningful cross-country differences in nominal wage growth.

Inflation and monetary policy: close to target, rates on hold

Headline inflation in the euro area has stabilized near 2% amid falling energy prices, stagnant core goods prices, and still slightly elevated services inflation. Inflation divergence persists across Europe due to differences in wage growth, administered prices, and tax changes. Price growth continues to be elevated in some CEE countries, particularly Romania, while in Switzerland, France, Italy, and Finland, inflation is subdued.

With inflation near target and GDP growth close to potential, the ECB has kept the deposit rate at 2.0% since June 2025. Most other European central banks are also in wait-and-see mode, as rates are either close to their neutral level (Switzerland, Sweden, Czechia) or monetary policy remains restrictive in the face of persistent price pressures (Romania, Norway). Only a couple of central banks (the Bank of England and the National Bank of Poland) have continued to cut rates in recent months, although not at every policy meeting. In February, the National Bank of Hungary restarted its easing cycle following a lengthy pause.

At the same time, central banks continue to reduce bond holdings, which effectively softens the impact of past interest rate cuts. Quantitative tightening, alongside expectations of looser fiscal policy, is one of the reasons why bond yields have moved largely sideways in recent quarters despite rate cuts. Still, steady yields do not mean that interest rate cuts are not influencing economic activity: bank lending has picked up in recent quarters, broadly returning toward pre-pandemic growth rates.

That said, cross-country divergences are visible in the euro area. Bond yields have been trending higher in Germany (fiscal easing) and France (political gridlock). Conversely, Italian yield spreads over German bonds have been gradually narrowing, supported by the country’s successful fiscal consolidation efforts.

The euro remains strong versus the USD. Meanwhile, Swedish krona, Hungarian forint, and Czech koruna appreciated against the euro in 2025 following earlier weakness. In contrast, the sterling depreciated.

GDP Growth Outlook

  • We expect underlying euro area growth (excluding Ireland) to continue gradually accelerating, driven by:
    o    Ongoing investment recovery, supported by lower interest rates, improved profits, and higher government spending
    o    Reacceleration in consumption as saving rates stop rising
    o    Continued (if challenged) export growth 

Despite the improvement in these underlying trends, headline euro area growth is expected to slow to 1.3% in 2026 from 1.5% in 2025, primarily because Ireland’s 2025 surge unwinds. Growth should re-accelerate to 1.4% in 2027 and 1.5% in 2028-29.

Country highlights:

  • Germany: expected to exit stagnation, but growth should remain moderate, as fiscal expansion does not address underlying structural issues. We forecast 0.6% growth in 2026 constrained by tariff headwinds and a slower-than-planned stimulus rollout. Growth is then expected to accelerate to 1.2-1.3% in 2027-29 as the fiscal package reaches its peak impact, but structural constraints (unfavorable demographics, reduced industrial competitiveness) will continue to weigh on performance.
  • UK: growth is expected to slow in 2026 following the 2025 acceleration, reflecting weaker household income growth and ongoing global uncertainty. It is then anticipated to recover to 1.3-1.4% as these headwinds ease.
  • France and Italy: projected to grow steady around potential: 1.1-1.3% and 0.7-1.0%, respectively, over 2026-29.
  • Spain: projected 2.7% growth in 2026, supported by immigration and tourism; anticipated to gradually slow as these tailwinds fade (2.2% in 2027, 1.8% in 2028, 1.4% in 2029).
  • The Netherlands: GDP growth is expected to slow to 1.3% in 2026 as exports and private consumption lose momentum after earlier gains, reflecting the impact of US tariffs and moderating wage growth. From 2027 onward, growth should recover to ~1.7% as investment accelerates.
  • Nordics: expected cyclical recovery following earlier housing and labor market busts, with GDP growth fluctuating around 2% across the region. Activity in Norway and Denmark is likely to remain volatile due to fluctuations in the oil and gas and pharmaceutical sectors.
  • Poland: strongest among large European economies at 4.1% growth in 2026, supported by real income gains, NextGenEU, and military investment, before slowing toward ~2.5% as public investment plateaus and demographic constraints increasingly weigh on potential growth.
  • Other CEE economies: expected robust GDP growth in the 2-3.5% range, supported by continued expansion of real incomes and industrial recovery. Croatia and Bulgaria should be among stronger performers, while Romania is anticipated to remain weaker due to fiscal tightening but improving from the current very slow growth.
  • Turkey: growth is projected to fluctuate in the 3-4% range as potential growth is lower than in the past due to less favorable demographics. GDP growth is likely to strengthen in 2027 as pre-election spending is expected to rise (increasing social benefits and public sector wages).

Inflation Outlook

Inflationary pressures are expected to remain contained in the euro area, with headline and core inflation staying close to 2% throughout the forecast horizon:

  • Core and food inflation are expected to ease to 2% by mid-2026 from ~2.5%.
  • Services inflation is projected to gradually slow down alongside wage growth normalization.
  • Energy inflation near 0% should keep headline inflation in the 1.7-2.0% range.

In 2028, energy inflation may rise if the planned ETS extension takes effect, potentially pushing headline inflation slightly above 2%.

Country highlights

  • In Romania, inflation is projected to stay high in the first half of 2026 due to large energy price and VAT hikes implemented last year, but should ease toward 3% thereafter supported by subdued demand and more conservative government wage policy.
  • Inflation should also remain above 3% in several other CEE economies (Slovakia, Bulgaria, Croatia) due to energy price increases and persistent price pressures in services driven by strong wage growth.
  • In contrast, Switzerland is flirting with deflation due to weak wage growth and a strong Swiss Franc, while low wage growth keeps France’s inflation near 1%.
  • Negative output gaps and indirect tax cuts are likely to push inflation below 2% across most Nordic economies, with Norway as an exception, where price pressures remain stubborn.
  • In Turkey, gradual disinflation is expected, from 31% at end-2025 to around 14% by 2029, though a return to full price stability may remain challenging under the current monetary policy framework.
  • For most other countries, we anticipate inflation within the 1.5-3% range, with Germany’s price growth easing and stabilising just below 2%.

Monetary Policy Outlook: ECB on hold

  • Fed: We expect the Fed to remain on hold in the first half of 2026, before delivering additional 50 bps of cuts in in the second half of the year.
  • ECB: With inflation near target and GDP growth holding steady, the ECB is likely to keep rates unchanged. Risks are tilted to the downside if growth weakens or inflation undershoots materially.
  • BoE: We expect the Bank of England to deliver its final 25 bps cut in April, with rates held at 3.5% thereafter. Risks are tilted towards more easing if growth continues to disappoint and labor market softens further.
  • SNB: We anticipate the Swiss National Bank to keep the policy rate at 0% through end-2027. Rates may increase towards the neutral level of 0.5% afterwards.
  • Norway: We expect the central bank to resume gradual cuts in 2H 2026, bringing the policy rate to 3% only by 2028 due to slow core inflation easing.
  • Sweden: We expect one additional cut by Riksbank as inflation should undershoot the target amid negative output gap.
  • CEE: Some further policy easing is expected.
    o    Poland: The National Bank of Poland (NBP) is anticipated to deliver cuts in March and April (in total 50bps), bringing the policy rate to 3.5%.
    o    Czechia: The CNB rates should be maintained in 2026, followed by 50 bps easing in 2027 when core inflation falls to 2%.
    o    Hungary/Romania: The central banks are expected to proceed with interest rate reductions as price pressures finally subside. In Hungary, we project a total of 100 bps of easing in 2026, including the initial cut already delivered, followed by 150 bps of additional easing in 2027. In Romania, we expect 50 bps of cuts in 2026, with a further ~100 bps likely in 2027.
  • Turkey: We expect continued cuts with gradual disinflation. Rates may fall to 27% by year-end.

Key risk factors:

1. Geopolitics: Escalating US–Iran tensions have become the key near‑term global risk, raising uncertainty through potential impacts on energy prices, confidence, investment decisions, and cross‑border flows. Russia’s war against Ukraine and broader geopolitical frictions further weigh on the outlook. De‑escalation in either region would reduce uncertainty, compress risk premia, and support investment.

2. Tariffs and Trade Policy: The US-EU trade deal reduces the probability of sustained escalation, but uncertainty remains due to political and legal shocks. Tariffs continue to impact the economy, leading to structural reconfiguration of trade patterns.

3. Fiscal Dynamics: Expected boost in defense and infrastructure spending should support activity, but uneven fiscal positions, especially risks in France and Italy, could weigh on growth.

4. Exchange Rate and Competitiveness: A stronger euro helps ease inflation but hurts export competitiveness. While we expect exports to gradually improve, risks of stagnation remain due to structural challenges, including increasing competition from China.

5. Energy and commodity prices: Geopolitical shocks could quickly push prices higher and erode real incomes—especially for energy‑sensitive CEE economies—while uncertainty around the inflationary impact of the EU Emissions Trading System adds another layer of risk. Conversely, easing tensions or improved supply conditions could lower risk premia and support growth.

6. Asset Prices and Financing Conditions: Corrections in asset prices can reduce confidence and delay investment. Tighter financial conditions would raise capital costs and limit credit availability for firms.

7. Structural Risks and Opportunities: Europe’s long-term competitiveness is constrained by high costs and an aging workforce. Growth could improve if the region accelerates automation/digitalization and expands investment in skills and infrastructure. However, stronger resistance to immigration would further tighten labor supply and worsen demographic headwinds.

Conclusion:

Europe’s recovery is underway but fragile. Underlying growth is improving, inflation is near target, and policy settings are broadly supportive. But tariffs, geopolitics, and structural issues keep the balance of risks tilted to the downside.

Over the medium term, Europe’s performance will increasingly hinge on one question: can the region raise productivity fast enough—through AI adoption, digital investment, and skills—to offset demographic headwinds and intensifying global competition?

About the report

The EY European Economic Outlook is a quarterly report prepared by the EY Economic Analysis Team, led by Marek Rozkrut, Chief Economist for Europe and Central Asia. The report analyzes macroeconomic developments, including economic growth, labor markets, inflation, monetary policy and key risk factors. Each edition of the outlook includes macroeconomic forecasts for European countries and selected major economies. Both baseline and alternative scenarios are presented, with forecasts prepared using a large, integrated model of the world economy.

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