Euro area – Bright past, blurred future

The Euro area economy is steadily recovering, marked by increasing growth, a robust labour market, and inflation meeting the 2% target. Although the recovery is anticipated to persist this year, growth is likely to remain below potential due to trade uncertainties and cautious consumer behaviour. By 2026, growth is expected to accelerate, driven by previous monetary policy easing and enhanced public investments.

We perceive the risks to economic growth as tilted to the downside this year due to the US trade policies, whereas potential increased consumption share and fiscal spending balance the risks in 2026.

The fight against inflation is almost over and inflation is expected to fluctuate around the 2% target in the entire forecasting period. Falling wage growth and energy prices will support the disinflation process and even cause inflation to markedly undershoot the 2% target in 2026Q1. We view the risks to inflation as balanced since energy prices could increase more than expected while growth could be weaker than projected.

The ECB is anticipated to reduce the deposit rate to 1.5% this year, as we believe it is necessary to move into slightly accommodative territory to prevent de-anchoring inflation expectations and support activity below potential amidst trade uncertainty. The balance of risks regarding our prediction leans towards fewer interest rate cuts than our baseline forecast.

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