OECD Economic Outlook, Volume 2026 Issue 1

Euro area

GDP growth is projected to slow from 1.4% in 2025 to 0.8% in 2026, before picking up to 1.2% in 2027 as domestic demand and trade growth strengthen. Private consumption will be supported by resilient labour markets and a modest reduction in the household saving rate. Private investment will be constrained by uncertainty, while public investment will be supported in 2026 by the Recovery and Resilience Facility funds. Wage growth is projected to ease gradually, helping inflation to return to target after the energy price shock linked to the evolving conflict in the Middle East.

Fiscal policy is projected to remain broadly neutral in 2026 and mildly tighter in 2027. Although defence spending is set to increase, prudent fiscal policy is needed to rebuild fiscal buffers and ensure medium-term fiscal sustainability. Amid elevated uncertainty, monetary policy should also remain vigilant to ensure that inflation returns durably to target. To help improve energy security, reduced tax rates and tax exemptions for fossil fuels should be phased out and investment in cross-border electricity grid connections strengthened.

Uncertainty weighs on the economy

GDP grew by 0.1% quarter on quarter in the first quarter of 2026. The evolving conflict in the Middle East is continuing to weigh on activity, following a sharp decline in oil exports, particularly diesel and jet fuel, from the Gulf countries. Recent indicators suggest deteriorating sentiment, and a balance of firms in the May composite PMI survey reported that output declined, reflecting higher energy prices and weakening demand. Higher energy prices pushed up headline inflation to 3% in April, but core inflation remained at 2.2%, mainly reflecting elevated services inflation which has not dropped below 3% since April 2022. At the same time, the euro remained strong, close to historic highs against a basket of 41 currencies, and medium-term market-based inflation expectations stayed broadly stable around the 2% target. The labour market is cooling, with both employment growth and nominal wage growth slowing in the second half of 2025. Even so, the seasonally adjusted unemployment rate remained close to its historic low, at 6.2% in March. Financial conditions have tightened somewhat, particularly for loans to firms, and banks expected the tightening to continue in the first quarter of 2026.

The current account recorded a surplus of 1.7% of euro area GDP in the 12 months to March 2026, reflecting a lower services trade surplus and a lower balance of goods trade following the closure of the Strait of Hormuz, through which the EU imported about 5% of its crude oil, 10% of LNG and 45% of jet fuel. In August 2025 the US introduced a 15% tariff on imports of EU goods, including cars and parts, with a 50% tariff on imports of steel and aluminium as well as products made of these metals. The EU has stopped applying a 10% levy on US car imports and further postponed its retaliatory measures. In February 2026, following the ruling of the US Supreme Court, the US administration introduced a new 10% global tariff to replace the previous levies. In May, the European Parliament agreed in principle to ratify the EU‑US framework agreement, with final adoption pending. In support of Ukraine, EU countries have extended temporary protection to more than 4 million refugees until March 2027. This has helped to reduce labour shortages in low-wage sectors in some EU countries. The EU has so far disbursed more than EUR 36 billion (0.3% of euro area GDP) from the EUR 50 billion Ukraine facility and provided EUR 17 billion (0.1% of euro area GDP) to help EU countries address the needs of Ukrainian refugees.

Euro area 1

1. The dashed line indicates the ECB's inflation target of 2%.

Source: OECD Quarterly National Accounts database; Eurostat Unemployment rates by sex, age, citizenship database; and Eurostat Harmonised index of consumer prices (HICP) database.

Statlink

Euro area: Demand, output and prices

Statlink

Euro area 2

1. Gross general government interest payments.

2. Maastricht definition.

3. 5-year inflation expectations 5-year ahead derived from swap contracts.

Source: OECD Economic Outlook 119 database; European Central Bank (ECB); Eurostat; and OECD calculations.

Statlink

Macroeconomic policy will remain broadly neutral

The aggregate euro area fiscal stance tightened slightly in 2025 but is projected to remain broadly neutral in 2026 and mildly tighter in 2027, even though further discretionary support measures may be introduced if the Middle East conflict continues. Spending under the Recovery and Resilience Facility (RRF) could provide support of about 0.5% of GDP in 2026, if disbursed fully as planned. The end of the programme as well as withdrawal of the energy support measures will help make fiscal policy mildly tighter in 2027. Russia’s war of aggression against Ukraine has triggered additional military spending. In the countries that opted for the coordinated use of national escape clauses under the EU fiscal rules, additional defence spending could amount to more than 1% of GDP by 2027. In January 2026, the Commission approved loan agreements with 16 EU countries amounting to EUR 112 billion under the Security Action for Europe (SAFE), which will need to be repaid after a 10-year grace period.

The European Central Bank’s monetary policy stance is broadly neutral, with the deposit facility rate remaining at 2% since June 2025. Uncertainty surrounding the duration of the energy price shock, the scope of the pass-through to core inflation and the design of fiscal support calls for vigilant and prudent monetary policy, to ensure that inflation is durably reduced to the 2% target. The policy rate is projected to increase by 25 basis points in 2026, before being lowered back to 2% in the last quarter of 2027, reflecting the need to prevent inflation expectations from de-anchoring.

Economic growth will gradually rebound from the current slowdown

Growth is projected to slow to 0.8% in 2026, amidst the evolving conflict in the Middle East, before picking up in 2027 helped by a rebound in trade. The labour market will remain tight, with labour shortages in some sectors and historically low unemployment slowing wage growth normalisation. Growing real disposable incomes and a lower household saving rate should support private consumption. Elevated uncertainty will weigh on private investment, but public investment will be supported by the last year of the RRF spending in 2026. Headline and core inflation are projected to moderate towards the target as the energy price shock in the middle of 2026 gradually dissipates.

Risks to the projections are tilted to the downside. A longer conflict in the Middle East could lead to shortages and rationing of oil and natural gas in the euro area, reducing activity and pushing up inflation. In addition, worsening EU-US trade tensions would weigh on external demand, while trade diverted toward the EU could reduce demand for domestically produced goods. Financial stability risks associated with a rapidly shifting geopolitical environment can be amplified by an abrupt repricing of sovereign risk. On the upside, a durable peace in the Middle East and a reduction of trade tensions could help lift external demand and bring down inflation.

Prudent macroeconomic policies need to be reinforced by structural reforms

The investment needs associated with defence and continuing decarbonisation are considerable. To contain public debt and rebuild fiscal buffers, reprioritisation of spending and prudent fiscal policy will be needed to address other spending pressures, such as population ageing. To limit fiscal costs, new energy support measures need to be temporary and targeted. The activation of national escape clauses under the EU fiscal rules may further delay the reduction of existing excessive deficits. Compliance with the fiscal rules should be carefully monitored to establish the credibility of the new framework and safeguard medium-term fiscal sustainability. The monetary policy stance should not be eased prematurely to ensure that inflation expectations remain firmly anchored. To encourage electrification, reduced tax rates and exemptions for fossil fuels should be phased out. In addition, investment in cross-border electricity grid connections should be stepped up and should meet rigorous cost-benefit analysis criteria.