European Growth Outlook: Energy price shock weighing on Euro area growth

EUROPEAN GROWTH OUTLOOK

Energy price shock weighing on Euro area growth

▪ Dampened growth in the Euro area: The energy price shock triggered by the Iran conflict is tangibly weighing on economic development. Economic output is expected to grow by a muted 0.7 percent in 2026. Consumption is likely to remain the main driver of growth, with hardly any upward movement anticipated from investment and downward momentum from foreign trade.

▪ The outlook depends largely on energy markets: Even if energy prices ease off substantially and swiftly, the pick-up in economic momentum will remain limited. Otherwise, stagnation is on the cards, and a recession is not off the table if the Strait of Hormuz remains blocked throughout the rest of the year.

▪ Stabilising impetus remains low: The energy price shock is driving inflation up while the economy is losing steam making the situation challenging for monetary policy. The decisive factor will be whether price pressure builds up through expectations and second-round effects. Until now, only moderate interest rate hikes are anticipated. Regarding fiscal policy, moderation is the order of the day with very targeted relief measures. More restrictive financing conditions and burdens from trade policy and global competition represent additional downward forces.

▪ Strengthen structural growth conditions: Looking beyond short-term developments, improving investment conditions and implementing structural reform is crucial to lay the foundations for stronger growth. Progress in the internal market and the diversification of trade and supply chains remains key to broaden the basis for growth and strengthen competitiveness.

Introduction

The Euro area began 2026 with weak but still positive growth momentum. Although gross domestic product rose slightly in the first quarter, year on year, the pace of growth has tailed off considerably continuing the slowdown seen since the second half of 2025. While private consumption is still propping up growth, central areas, particularly industry, retail and early indicators, are increasingly losing steam

The outlook for 2026 is largely defined by the escalating conflict in the Middle East which is currently the main source of pressure for European industry. The impact is largely being transmitted through steeply increasing energy prices which diminish household purchasing power and increase corporate costs. At the same time, the resulting heightened uncertainty, unfavourable financing conditions and weaker global demand is tangibly curbing investment and consumption. Foreign trade is also being weighed down by the persisting trade tensions, particularly in relations with the United States, and mounting international competitive pressure, which is additionally stifling economic development. The labour market remains robust but is losing momentum and increasingly less able to cushion the economic slowdown.

In this environment, the economic policy response remains limited. Monetary policy is stepping cautiously, confronted with the challenge of combating the rising inflation fuelled by surging energy prices combined with flagging economic momentum. Fiscal policy is also only providing moderate impetus as restricted fiscal space is constricting additional expenditure. Overall, economic policy measures will only be able to compensate partially for the downward forces of the shock.

In this context, we forecast baseline Euro area growth of around 0.7 percent in 2026 overall, which is well below potential growth. To factor in the high degree of uncertainty regarding this forecast, we have also added a scenario corridor. While a swift de-escalation could lead to a slight pick-up, there is a significant risk of a further slowdown in growth or stagnation if the conflict persists or escalates. The risks are therefore heavily tilted to the downside.

Our growth outlook presents a compact overview of the key macroeconomic developments in the Euro area, examines the main economic drivers and risks, and puts the role of fiscal and trade policy drivers into a European context with the objective of providing decision-makers in politics, business and society a solid basis for strategic assessments and economic policy decisions

Economic situation in the Euro area

The Euro area economy started out the year 2026 on a muted but stable upward trend The macroeconomic indicators for the first quarter do not yet fully reflect the economic impact of the military conflict between the United States, Israel and Iran that has been ongoing since the end of February, as the costs particularly of higher energy prices and possible disruptions to supply chains will only become apparent further down the line.

In the first quarter 2026, seasonally adjusted gross domestic product (GDP) in the Euro area was 0.1 percent higher than in the previous quarter, according to Eurostat, down from 0.2 percent in the fourth quarter 2025. Year on year, seasonally adjusted GDP in the Euro area was 0.8 percent higher, after notching up a rise of 1.3 percent in the previous quarter.

Among the member states for whom first quarter 2026 figures were already available, Finland recorded the strongest quarter on quarter growth with an increase of 0.9 percent, followed by Hungary (+0 8%), Estonia and Spain (both +0 6%). Negative growth was recorded by Ireland (-2 0%), Lithuania (-0 4%), Sweden and Romania (both -0 2%). Year on year, 17 member states recorded growth while two contracted.

As shown in the following figure, the pace of growth in the Euro area (EMU-20) has been slowing down since the second half of 2025, after expanding around 1.6 percent year on year in the first and second quarter 2025. Economic growth continues to be fuelled largely by private consumption. A positive trend in 2025 was that investments also contributed significantly more to growth. With rising trade tensions and more intensive international competition, net exports have most recently made a negative contribution to growth.

Sources: Macrobond, ECB

After following negative growth rates in the less volatile two-month comparison between May 2023 and January 2025, weighed down by the internationally comparatively high energy prices, among other factors, industrial production turned up in February 2025, recording an average year on year growth of around 1.6 percent until January 2026 According to the latest figures available, production then turned down again in February. It remains to be seen whether this is just a temporary blip or if it marks the beginning of another

Industrial production* in the Euro area, in percent

*Volume index, 2-month-average, seasonally adjusted

Sources: Macrobond, Eurostat

Spurred by the upward trend in industrial production in the course of 2025, capacity utilisation rates also rose slightly, reaching a seasonally adjusted 78.5 percent at the beginning of the second quarter 2026. This is still below the average of the last ten years of 80.3 percent, indicating subdued industrial activity overall. Given the downturn in industrial production most recently, capacity utilisation is not likely to rise rapidly any time soon.

Capacity utilisation* in the Euro area, in percent

*seasonally adjusted

Sources: Macrobond, DG ECFIN, European Commission

In view of the renewed downturn in industrial activity, it is well worth looking at the shape of the retail sector, which is a key indicator for consumer demand and, thus, the strength of the domestic economy. Particularly in a phase of flagging industrial momentum, private consumption can play a central role in overall economic development.

As shown by the following figure, the Euro area retail sector has pointed up since March 2024, significantly earlier than the industrial sector The uptrend in the retail sector was particularly pronounced between August 2024 and July 2025 with growth averaging 2.6 percent. Since 2025, momentum has slowed down slightly to around 1.7 percent, falling further to around 1.1 percent in March 2026.

Euro area (20) retail trade* (excluding motor vehicles)

*change over previous year, calendar and seasonally adjusted

Sources: Macrobond, Eurostat

Price development: Inflation increases on the back of rising energy prices

The energy price shock triggered by the Iran war is now clearly feeding through to inflation rates in the Euro area According to Eurostat, annual inflation in April 2026 was at three percent, up from 2.6 percent in March. At the start of the year, inflation had been well below target at 1.7 percent in January and 1.9 percent in February.

The most recent rise in inflation is primarily due to the surge in energy prices. Energy inflation in April stood at 10.9 percent (after 5.1% in March and -3.1% in February). The other inflation components are still relatively stable in comparison, with prices of services increasing by 3.0 percent (after 3 3% in March and 3.4% in February) and prices of food, alcohol and tobacco rising by 2.4 percent (after 2.4% in March and 2 5% in February), while prices of industrial goods excluding energy only increased by a moderate 0.8 percent (after 0 5% in March and 0 7% in February).

This pattern is confirmed by the development of core inflation (excluding energy), which dropped down to 2.2 percent in April (after 2 3% in March and 2 4% in February) and indicates that the pressure on prices in the domestic economy is continuing to decline despite the geopolitical upsets.

Within the Euro area there are still considerable differences between the individual member states. Inflation rates in April ranged from six percent in Bulgaria and 5.4 percent in Croatia down to 2.4 percent in Finland. In the major economies, inflation was at 2.5 percent in France, 2.8 percent in Italy, 2.9 percent in Germany and 3.5 percent in Spain. These divergent rates of inflation highlight the varying extent to which the energy price shock is passed on in the individual countries and the different framework conditions this sets for short-term economic development.

According to the European Central Bank (ECB, 2026a), the indicators of underlying inflation have not changed much over recent months. For now, the ECB’s wage tracker and surveys on wage expectations indicate easing labour costs in the further course of 2026. At the same time, business surveys indicate that other cost components and selling price expectations are set to rise

Inflation expectations have increased substantially particularly for the short term, reflecting the most recent energy price increases and the heightened geopolitical uncertainty. Most indicators for longerterm inflation expectations nonetheless remain within the target range at around two percent.

Contributions* to inflation in the Euro area

*Change over previous year

Sources: Macrobond, European Central Bank

Leading indicators and sentiment: Weakening momentum and growing uncertainty

Leading indicators currently point to a growing slowdown in growth prospects in the Euro area. The Composite PMI compiled by S&P Global fell below the expansion threshold for the second month in a row in May, dropping to 47.5 points (from 48.8 in April). This marked a 31-month low for the index. Declines were seen in both the manufacturing and services sectors, with the latter continuing to be significantly more pronounced.

At the same time, price pressures continued to intensify: input prices rose at their fastest rate in three and a half years, whilst selling prices also increased significantly. However, as costs rose more sharply than selling prices, this points to increasing pressure on margins. In parallel, the business climate deteriorated once again and remains close to a multi-year low, whilst job cuts have recently increased and are now also affecting the services sector. Overall, this points to an environment of further slowing growth momentum coupled with persistently high price pressure, thereby signalling increasing stagflationary tendencies.

At the national level, the picture is mixed: the downturn was particularly pronounced in France, where the Composite PMI fell sharply to 43.5 points, reaching its lowest level since the end of 2020. Declines in manufacturing and services, falling new orders and a significant rise in costs all weighed equally on economic activity. However, the decline may have been temporarily exacerbated by calendar effects (numerous public holidays and long weekends in May) (DB Research 2026e). Despite a slight improvement, Germany remains in contractionary territory for the second month in a row at 48.6 points, with weak demand and declining order intake shaping the trend. Overall, the picture in the major economies remains weak and mixed.

At sectoral level – in line with S&P Global’s assessment – the services sector in particular remains under pressure, having recorded its sharpest decline since early 2021 in May. The main factor is weak demand resulting from higher living and energy costs. By contrast, the manufacturing sector continues to show relative resilience, but is losing momentum as the previously supportive effects of inventory build-up are waning and order intake is now also declining. Overall, this suggests that the weakness is spreading increasingly broadly across both sectors.

Business confidence indicators* in the Euro area

Sources: Macrobond, DG ECFIN, European Commission

The slowdown in momentum indicated by the PMIs is also confirmed by other sentiment indicators. The indicators compiled by the European Commission have all fallen substantially in recent months. The drops were particularly pronounced in the retail and the service sector, with indicators falling 4.5 and 3.3 points respectively between February and April. Sentiment in the industrial sector also

clouded over, but more moderately (down 1.1 points within the same period). In comparison, the construction sector was relatively stable, nudging down by a minimal 0.2 points.

In this environment of downward sentiment and early indicators, economic policy uncertainty in Europe increased slightly at last count, particularly in Germany. The Economic Policy Uncertainty Index rose tangibly in March before slipping back down a little in April in most major European economies apart from France. Overall, uncertainty remains high but is still below the extremely high levels seen during the escalation of the tariff dispute with the United States. The upward trend in uncertainty combined with the downward trends in sentiment indicators signalises the increasing overall fragility of the economic environment. Alongside the persisting uncertainties in trade policy, the most recent geopolitical tensions in connection with Iran have doubtlessly contributed to the temporary spikes in the perception of uncertainty.

Economic policy uncertainty index*

*news-based indicies

: Macrobond, Economic Policy Uncertainty

Growth outlook for the Euro area

Baseline scenario: Weaker growth below potential

In our baseline scenario for the Euro area, we expect the pace of growth to slow down considerably in 2026. After growing 1.4 percent in 2025 (EU: 1.5%), we expect growth of 0.7 percent in 2026 (EU: 0 9%). Our forecast is lower than the international forecasts published in March and April where the baseline scenarios were still comparatively more optimistic regarding the likelihood of a swift end to the Iran conflict and a correspondingly more moderate uptrend in energy prices. The Euro area forecast of the OECD is 0.8 percent, the ECB 0.9 percent and the IMF 1.1 percent.

The weaker momentum is reflected both in the early indicators and in real economic indicators. The confidence of businesses has tangibly declined most recently, and the PMI compiled by S&P is back in contractionary territory. At the same time, industrial production and retail have lost momentum, indicating an overall slowdown in economic activity.

The economic policy parameters also point towards subdued development. Monetary policy is currently largely neutral but likely to become slightly more restrictive in response to the latest rise in inflation. In this environment, the financing conditions have deteriorated somewhat already and are slightly more restrictive than forecast in December. Fiscal policy stances are divergent in the individual countries. In some countries, particularly Germany, higher investments and increasing defence spending is having a general expansionary effect, while consolidation efforts continue in other major economies, including France and Italy Furthermore, several member states have taken measures to cushion the effect of rising energy prices although these are likely to trigger only moderate overall economic impetus on account of the limited fiscal space available. The labour market remains robust although there might be a slight weakening in momentum during the period under analysis.

With this backdrop, we expect the energy price shock and heightened uncertainty to additionally curb economic momentum in the further course of the year. At the same time, we expect these effects to continue in the short term before gradually subsiding

Overall, growth in 2026 will be below the estimated potential growth of around 1.2 percent for the Euro area, indicating slight slack in the economy.

Drivers of growth: Subdued domestic impetus and negative net exports

Growth momentum in the Euro area is set to be fuelled largely by the domestic economy in 2026, although impetus will initially be subdued overall.

Private consumption is heading for a muted upward trend in 2026, with the rise in energy prices tangibly cutting into the purchasing power of households. The continuing robustness of the labour market will cushion these effects in part but will not be able to fully compensate the reduction. The diminished purchasing power is likely to prompt households to fall back on their savings more, which will cause the savings rate to nudge down. The heightened level of uncertainty will meanwhile work the other way, curbing this decrease and additionally weighing on consumption momentum.

Investment levels are also set to remain weak in 2026. Corporate investments will continue to be curbed by the heightened uncertainty, subdued demand and tighter financing conditions, while investment in construction is only heading to recover gradually. The primary upward force, on the other hand, will be higher public investment, particularly in defence and infrastructure, although the impetus will remain limited overall due to the general downward factors.

Public demand is set to make a moderate contribution to growth overall in 2026. This will be driven primarily by higher state consumption expenditure in the form of rising defence expenditure as well as fiscal measures to cushion the higher energy prices in individual member states. At the same time, continuing consolidation efforts in several major economies will constrict the overall economic impetus, diminishing the cumulative contribution to growth.

Foreign trade is heading to make a slight negative contribution to growth in 2026. Growth in exports will be weak in view of the continuing problems with competitiveness and subdued demand for goods in the Euro area. The demand for imports, on the other hand, is only expected to be slightly muted and increase moderately. As exports will therefore grow less than imports, the overall contribution of net exports to growth will be negative.

Iran conflict: Scenarios and implications for the Euro area

The continuing conflict with Iran represents the central source of uncertainty in the European growth outlook for 2026. The conflict impacts the economy through three main channels: (i) higher energy prices on account of disrupted oil and gas exports, particularly through the Strait of Hormuz; (ii) increasing geopolitical uncertainty and more stringent financing conditions; (iii) negative global spillovers through trade and supply chains. Any physical disruptions to supplies and bottlenecks additionally augment the effects on the real economy. The magnitude of these effects depends largely on the duration and scale of escalation of the conflict and the persistence of any supply-side disruptions

Baseline assumptions and current energy price developments

Our forecast for the Euro area (0 7% growth in 2026) assumes a considerable but not extreme energy price shock but one which is more persistent than in many international baseline scenarios. While these assume a gradual decrease in energy prices throughout the year, we assume that uncertainty, energy prices and the consequent curbing impact on investment and consumption will last longer.

The latest market developments already indicate a stronger and, so far, more persistent surge in energy prices than assumed in many international baselines. As the figure shows, oil prices have risen significantly since the start of the conflict and are currently, on average for the second quarter of 2026 (as at 21 May 2026), around 50-55 percent higher than the average for 2025. European gas prices are also showing a clear upward trend and are currently around 30 percent higher than the previous year’s level.

Price Developments for Oil and Gas (Brent & LNG) (1 January 2025 – 21 May 2026)

Source: Macrobond

In contrast to the swift normalisation assumed in many baseline scenarios, current price trends are not indicating any clear easing yet Rather, the combination of continuing uncertainty, tense gas markets and limited shortterm increases in supply signalise that price pressure will remain markedly increased throughout the current year, at least. Our baseline factors this in and lies between the international baselines and moderate adverse scenarios, tending more towards the latter.

International scenarios in comparison

1) ECB projections (March 2026)

The ECB baseline is based on the assumption that energy prices will peak at around 90 US dollars per barrel and 50 euros per MWh of gas in the second quarter 2026, followed by a swift decrease. The resulting forecast for Euro area growth in 2026 is around 0.9 percent.

The ECB also analyses alternative scenarios:

• Adverse scenario: Temporary disruption of around 40 percent of energy flows transiting through the Strait of Hormuz; oil prices close to 120 US dollars; gas prices close to 90 euros per MWh. Growth in 2026 here is around 0.3 percentage points below baseline growth

• Severe scenario: More intense and prolonged disruption to the energy supply including damage to infrastructure (affecting up to 60% of energy flows); oil prices up to around 145 US dollars, gas prices over 100 euros per MWh. Growth in this case is expected to be around 0.5 percentage points below the baseline with temporarily negative quarterly growth rates

A milder scenario with faster normalisation implies slightly higher growth rates (+0 1 percentage points). In its baseline scenario, the ECB also expects the pace of growth to pick up from 2027 onwards, with the negative effects of the energy price shock and heightened uncertainty subsiding over time.

2) OECD projections (March 2026)

The OECD baseline assumes that energy prices will gradually normalise from the middle of 2026 in line with futures markets pricing, without citing explicit price levels The resulting forecast for Euro area growth in 2026 is around 0.8 percent. In the medium term, the OECD expects a gradual recovery as pressure on energy prices subside with the caveat that this could be delayed if prices remain high or bottlenecks form

The scenario analysis highlights the considerable sensitivities of these projections:

▪ Downside scenario: Markedly higher energy prices with oil prices of around 135 US dollars per barrel and gas prices of around 77 euros per MWh in the second quarter 2026 considerably dragging on global demand On an annual average, this corresponds to around 26 percent higher oil prices and 17 percent higher gas prices than in the baseline. Global gross domestic product after two years would be around 0.5 percent lower than the baseline growth of 2.9 percent; for Europe (not the Euro area), growth would be around 0.4 percent lower in the first year.

▪ Upside scenario: Quicker-than-anticipated de-escalation leads to an average decrease in energy prices of around 20 percent compared to the baseline in the first year of the shock. In contrast to the downside scenario, this scenario does not specify an explicit price level or quarterly figures. The positive effects are correspondingly lower energy prices and higher real incomes. The OECD quantifies the effects at the global level with an increase in gross domestic product of around 0.3 percent in the second year.

3) IMF projections (April 2026)

In its reference forecast, the IMF assumes the conflict will subside relatively rapidly with energy production and transport normalising by the middle of 2026 and oil prices therefore averaging around 82 US dollars per barrel in 2026 overall. The IMF does not specify any prices for gas but emphasises that these react more strongly to the shock than oil prices. For the Euro area, these assumptions lead to forecast growth of around 1.1 percent in 2026.

The scenario analysis highlights considerable downside risks:

▪ Adverse scenario: A pronounced energy shock with an increase in oil prices of around 80 percent from the second quarter 2026 (corresponding to an annual average of around 100 US dollars in 2026) and gas price increases of around 160 percent, leading to significantly higher inflation and tightening financing conditions Global growth in 2026 would be around 0.8 percentage points lower (baseline:

3 1%).

▪ Severe scenario: An even more pronounced and prolonged energy shock with oil prices over 110 US dollars in 2026 and gas price increases of around 200 percent, leading to considerable burdens on the real economy. Global growth in 2026 would be around 1.3 percentage points lower with a considerable risk of recession.

The IMF does not set out any regional scenarios. The quantified effects all refer to the global economy. It is therefore not possible to derive any specific scenario effects for the Euro area other than that, as an energy importer, the Euro area would be particularly heavily affected by the global energy prices and financial market trends. In contrast to the ECB and the OECD, the IMF places greater emphasis on the role of inflation expectations, monetary policy response, and financial market channels as the central amplification mechanisms

Positioning our projections

In comparison to the international organisations, our baseline is more conservative for three reasons:

▪ More persistent energy shock: Many international baselines assume that energy prices will drop relatively rapidly. However, the current market development indicates a higher and more persistent price level, especially for gas

▪ Stronger uncertainty effects: The curbing effects on consumption and investment are looking to be more pronounced and prolonged on account of the continuing geopolitical uncertainty.

▪ Larger significance of bottlenecks and spillovers: We assume higher risks of physical disruptions to supplies, supply chain problems and global spillovers, particularly as the Euro area is an energy importer.

Our baseline forecast is therefore below the international baselines and more closely aligned to the moderately adverse scenarios, particularly of the ECB and OECD analyses. The IMF confirms this risk profile but does not include any specific scenarios for the Euro area

Our scenario corridor for the Euro area

Starting from our baseline (0 7% growth in 2026), the following range is plausible:

▪ Positive scenario (rapid de-escalation): A swift easing of the conflict could lead to a gradual normalisation of energy production and transport, supported by the reconstruction of damaged infrastructure in the Middle East and a stabilisation of supply chains. Energy prices could then drop substantially in the course of the year with oil prices well below the current level (well below 100 US dollars) and tangibly decreasing gas prices. In conjunction with declining uncertainty and more favourable financing conditions, Euro area growth in 2026 could, in this case, rise to around 0.8 to one percent.

▪ Negative scenario (prolonged conflict): A prolonged or renewed escalation of the conflict could disrupt energy production and transport for longer, for example with continued restrictions along key transport routes, particularly the Strait ofHormuz, and delay the repair of the damaged infrastructure in the Middle East. This could result in energy prices remaining at their current elevated levels or increasing further, particularly in the case of gas. In combination with heightened uncertainty and increasingly tighter financing conditions, this could considerably curb consumption and growth. Euro area growth in 2026 could, in this case, slow down to around 0.2 to 0.4 percent or even, at the lower end of the scale, trend towards stagnation

Conclusion

The scenarios imply a growth range for the Euro area in 2026 of around 0.2 to around one percent, with additional risks towards stagnation in case of a more pronounced escalation. The upward scope in the case of a rapid de-escalation is limited, while a more persistent energy shock would curb growth considerably more. For

this reason, our baseline of 0.7 percent growth is already more closely positioned to a moderately adverse scenario. The risks are therefore clearly tilted to the downside

Country analyses

Germany

At the start of 2026, Germany experienced a slight pick-up in economic activity. GDP increased by 0.3 percent in the first quarter 2026 compared to the previous quarter following price, seasonal and calendar adjustment The main drivers of growth were higher private and public consumption expenditure and, according to figures available so far, increasing exports. Year on year, real economic output was 0.5 percent higher, bringing hopes of a cautious stabilisation. In view of this development and the fiscal impetus expected in the further course of the year, a higher growth path seemed to be within reach at the start of the year. However, with the escalation of the Middle East conflict, the environment has deteriorated substantially. Higher energy and commodity prices and continuing high uncertainty are set to curb private investment activity particularly. Private consumption is on track for only moderate growth due to the reduced purchasing power. Foreign trade is not likely to provide any growth impetus in 2026. Exports will rise slightly, if at all, while imports are set to increase more which will result in another negative contribution to growth from net exports. Exports to key third country markets such as the United States and China are under particularly high pressure. Factoring in all these trends, we have downwardly revised our growth forecast. In our baseline scenario, we expect real GDP growth of around 0.4 percent for Germany in 2026.

France

Given the economy’s weak position at the start of the year, the growth outlook for France for 2026 is subdued. GDP stagnated in the first quarter (0.0%), with domestic demand especially feeble. Private consumption dropped somewhat and investments were also downward, so there was no contribution to growth from this side. At the same time, foreign trade pulled down growth with exports taking a plunge. Inventories brought a positive contribution but will only be a temporary stabilising force. Momentum should pick up a little as the year progresses. The IMF (2026), OECD (2026) and the Banque de France (2026) anticipate growth of around 0.9 percent in their baseline scenarios. The Banque de France expects growth to be largely fuelled by private consumption, which benefits from a positive growth carryover at the start of the year. Downward forces, on the other hand, are the dampening effects of the geopolitical environment, especially in the form of heightened uncertainty and higher energy prices. All things considered, we expect GDP growth of 0.5 percent in 2026. The main reason for our more cautious estimate is the weak momentum seen at the start of the year and the considerable negative result of net exports. In comparison to the baseline scenario of the IMF, OECD and the Banque de France, which were drawn up in March and April 2026, we expect the geopolitical environment to place more prolonged burdens on the economy.

Italy

Italy displayed a moderate but fragile upward momentum at the start of 2026. In the first quarter, GDP rose 0.2 percent compared to the previous quarter, according to Istat (2026). Growth was driven by services, while industrial and agricultural value added decreased. On the demand side, growth resulted

from the positive contribution of net exports, while domestic demand was downward. The statistical growth carryover to 2026 amounted to 0.5 percent. In the baseline scenario, the IMF (2026) and the Banca d’Italia (2026) expect growth of around 0.5 percent, while the OECD (2026) forecast is slightly more cautious at 0.4 percent. At the same time, the Banca d’Italia highlights the weak development of domestic demand, which is struggling under the elevated energy prices, heightened uncertainty and muted business sentiment. Momentum is set to stay subdued in the short term with both consumption and investment remaining weak. Foreign trade is also expected to provide a limited contribution to growth, with exports curbed by weak global demand and the contribution of net exports remaining low overall. In this context, we expect GDP growth of 0.3 percent in 2026. The main factors weighing on growth are the persistent weakness of domestic demand, limited foreign trade impetus and the assumption that the geopolitical environment will place more prolonged burdens on the economy.

Spain

The growth momentum in Spain is set to remain comparatively robust in 2026 but will show the first signs of weakening. According to IME, the Spanish statistical office, GDP in the first quarter was 0.6 percent higher than in the previous quarter, which is slightly lower than the pace of growth seen at the end of 2025. Year on year, growth continued to be solid at 2.7 percent. For 2026 overall, the IMF (2026) and OECD (2026) both expect growth of 2.1 percent. The Banco de España (2026) is more optimistic, with baseline growth of 2.3 percent, although it has downwardly revised its forecast slightly on account of the conflict in the Middle East. The primary downward forces for the growth outlook are assumptions of higher energy prices and the weaker development of foreign markets, while fiscal measures are set to cushion these effects in part. At the same time, these projections assume a relatively swift normalisation of the energy markets, in line with the market expectations at the time of forecasting. With this in mind, we expect GDP growth of 1.8 percent in 2026. The main reason for our more conservative estimate is the flagging momentum exhibited at the start of the year and more cautious assumptions regarding the energy markets.

Forecast overview

The following figure and table summarise our projections for the Euro area and the four largest member states (Germany, France, Italy and Spain).

Our forecast for the Euro area and the four largest EU countries is summarised in the following overview

Sources: Eurostat. Forecasts: BDI

Macroeconomic parameters

Global economy: Energy price shock reduces growth prospects

Until the start of 2026, the global economy had been on a path of solid growth despite persistent trade tensions. The upward trend was driven largely by robust private demand and dynamic investment activity, above all in technology-intensive areas such as artificial intelligence, and the overall supportive economic policy environment (OECD 2026, IMF 2026, ECB 2026b). In the second half of 2025, economic growth was higher than expected in many economies and indicators available at the start of 2026 also pointed to robust momentum going forward (OECD 2026).

On this basis, an upward revision of global growth prospects for 2026 would have been on the cards without any additional shocks. The update of OECD projections based on the data available at the end of February show that global growth could have been around 0.3 percentage points higher (OECD 2026). The IMF also highlights that, based on the economic momentum before the outbreak of the conflict, growth prospects would have brightened up (IMF 2026). This trend was overshadowed by the escalation of the conflict in the Middle East since late February 2026. The consequent rise in energy prices has largely neutralised the expected upward revisions and brought down growth prospects across the board (OECD 2026, IMF 2026, ECB 2026b).

In their baseline scenarios, the large international organisations still expect the global economy to expand moderately. Global growth in 2026 is expected to be between around 2.9 percent (OECD) and 3 1 percent (IMF). According to preliminary figures, growth in 2025 was around 3.3 percent or 3.4 percent (OECD 2026, IMF 2026). The projections of the ECB also indicate a slowdown and forecast growth for the global economy excluding the Euro area of 3.3 percent for 2026 after growth of 3.6 percent in 2025 (ECB 2026b). The slower pace of growth compared to the previous year is largely due to the energy price shock and the subsequent increase in production costs, reducing real purchasing power and increasing inflationary pressure (OECD 2026, IMF 2026). As well as the direct impact on costs and incomes, the shock also heightens uncertainty and affects the financial markets which have already responded with increased volatility, rising risk premiums and tighter financing conditions, all of which are additional forces weighing on investment and consumption (OECD 2026, IMF 2026, ECB 2026b) and further dampening economic activity. The ECB estimates that the conflict

will reduce global growth in the baseline scenario by around 0.4 percentage points over the next two years (ECB 2026b).

The projections assume that energy prices will gradually decrease again in the course of 2026 (OECD 2026, IMF 2026). The risks for development going forward remain firmly tilted to the downside. Modelbased calculations of the OECD project that a stronger and more prolonged rise in energy prices could reduce global production levels by around 0.5 percent within the next two years (OECD 2026). Scenario analyses of the IMF additionally show that global growth could drop to around 2.5 percent in 2026 in an adverse scenario and to around two percent in a severe scenario. The latter scenario assumes a more prolonged disruption of energy markets combined with an increase in inflation expectations and tighter financing conditions which would bring the global economy close to recession (IMF 2026).

Trade policy environment: Pressure from tariffs, uncertainty and global competition

The trading environment continues to be characterised by heightened uncertainty and numerous trade policy interventions that are greatly burdening the parameters of foreign trade for the European economy. The burden is not the result of individual measures but rather the combination of several different factors.

One of the main factors is US trade policy. Although the Supreme Court struck down tariffs based on the International Emergency Economic Powers Act (IEEPA), a global surcharge of ten percent was then immediately introduced under Section 122 initially limited to a period of 150 days. Although the US Court of International Trade ruled these tariffs to be unlawful and stopped their application in part for individual plaintiffs, the ruling was suspended temporarily by the US Court of Appeals so that the tariffs are currently back in place. In parallel, the US administration is pursuing the objective of continuing the tariffs using alternative instruments such as Section 301 investigations against key trade partners, including the European Union, while sectoral tariffs under Section 232 including for steel, aluminium, copper and their derivatives remain higher Further investigations under Section 232, including for drones, wind turbines, robotics and industrial machinery are still ongoing The burden on European companies therefore remains high overall, combined with continuing uncertainty about the course of US trade policy going forward. Recent announcements – including a possible increase in tariffs on car imports from the EU to 25 percent should the EU’s tariff cuts for the US not be implemented by 4 July 2026 – further highlight this uncertainty. On 19-20 May, however, a provisional agreement on the EU tariff reductions was reached in the trilogue; formal adoption is still pending. According to the estimates of the European Central Bank so far, the higher effective tariff rates in transatlantic trade and the associated uncertainty is set to curb growth overall by around 0.7 percentage points between 2025 and 2027, particularly on account of pressure on exports and investments (ECB 2025a).

At the same time, the trading environment is marked by structural shifts in global competition, particularly due to the economic development in China. A combination of weak domestic demand, persistent producer price deflation (although this has subsided most recently) and expanding capacities driven by industrial policy means that large volumes of low-priced industrial goods are reaching global markets. Cost differences and exchange rate factors which deteriorate the price competitiveness of European companies are additionally fuelling this development. This puts huge pressure on key industries including the automotive industry, machinery manufacturing and chemicals both in third countries and on the European internal market (BDI 2026). In contrast to trade policy

measures, the impact of this competitive pressure is not abrupt but structural and more persistent over time.

These factors are playing into the development of global trade but not immediately in the form of a direct reduction in trade. Despite the trade tensions outlined above, global trade was dynamic overall in 2025 and grew about 5.1 percent according to the International Monetary Fund. Growth resulted largely because the downward impact of trade barriers and uncertainty was partially compensated by robust global demand and strong growth in technology-related trade flows, particularly in relation to investments in digital and AI-related goods. Furthermore, international trade flows were tangibly restructured with a diversion of supply relations between major economic areas, such as the reduction of US imports from China in parallel with increasing imports from countries such as Vietnam and Taiwan and an increased rerouting of Chinese exports to other Asian economies and partially to Europe. The momentum of these upward factors is gradually subsiding, however, with a clear slowdown expected in 2026. The IMF (2026) forecasts growth in global trade to drop down to around 2.8 percent, concurring with the calculations of the ECB (2026b), as downward factors such as rising energy prices, rising geopolitical tensions and persistent economic and trade policy uncertainty increasingly dampen the momentum of demand, investment and international trade. Positive demand impetus will thus compensate the downward pressure less in 2026 than in the previous year.

In this setting, the diversification of trade is becoming increasingly important. The EU has recently advanced its trade agenda and concluded or moved forward on several economically relevant agreements, including with India, Australia and the Mercosur countries. Such agreements can help improve market access, secure export opportunities and reduce dependency on individual trade partners (BDI 2026). In the short term, however, downward factors such as higher trade barriers, continued uncertainty and intensified international competition will continue to predominate

Fiscal policy environment: Little impetus on the horizon

The fiscal policy in the Euro area is set to moderately support growth overall in 2026. Positive impetus will originate primarily from higher public investment and ongoing programmes. At the same time, the direct fiscal response to the current energy shock will remain limited with the fiscal rules in place setting clear boundaries for the fiscal scope available.

Fiscal impetus and public finances

After easing slightly in 2025, fiscal policy will become increasingly expansionary in 2026. According to the ECB (2026b), the fiscal impetus is expected to be around 0.3 percent of GDP which is tangibly more than in the previous year. Impetus will be greater particularly on account of higher public investment levels and additional transfers. Germany is a key driver of this upward trend with a marked increase in expenditure, particularly in defence and infrastructure. Other member states are also increasing their expenditure, but on a lower scale. Investments financed by the European recovery programme NextGenerationEU will also continue to bolster overall expenditure.

At the same time, the fiscal position is deteriorating further. General government deficit is heading towards about 3.4 percent of GDP this year, up from around 3.1 percent in 2025. It is expected to continue rising to around 3.6 percent of GDP in the next few years. The debt ratio is also increasing and will reach around 88.3 percent of GDP in 2026, with a further slight rise expected to follow. The rise in deficit is primarily due to increasing interest payments and a deterioration of the budget position

over and beyond cyclical effects (cyclically adjusted primary balance). The debt ratio has also continued to rise primarily because the level of economic growth has been insufficient to fully compensate for the current deficits.

Energy shock and fiscal measures

Fiscal measures in response to the energy shock have so far been limited overall. According to the calculations of Bruegel (2026), EU member states had approved measures amounting to more than eleven billion euros as of 5 May 2026 (see figure below). A large share of these measures has been taken by a few countries: In absolute figures, the highest shares are Spain (accounting for almost half of the total volume) and Germany. Relative to their economic output, smaller economies such as Bulgaria, Greece and Portugal have also taken considerable measures.

It should be noted that the Bruegel Tracker only includes measures with clearly quantifiable budgets and therefore does not include all announced or indirect measures.

The structure of these measures is decisive for their economic impact. Broad measures account for around 70 percent of funds spent, according to Bruegel, particularly in the form of reductions in taxes and charges related to energy. Although these measures stabilise purchasing power in the short term, they are less efficient than more focused support measures as they are not for a specific target group or provided under specific conditions and therefore also support less affected households and companies. At the same time, the focus is strongly on fossil fuels, while measures in electricity have been secondary so far.

The overall economic impact of these measures is consequently moderate. Compared to the energy crisis in 2022, the scope of these measures is much lower. While the fiscal support in the Euro area in

response to the 2022 energy crisis totalled around 3.6 percent of GDP, the volume of measures approved so far only amount to around 0.1 percent of GDP, according to the ECB. Projected estimates of the Deutsche Bank put the volume at around 0.3 percent of GDP (ECB 2026d, DB Research 2026c and 2026d).

A primary reason for the lower response is the smaller scale of the current energy and inflation shock. Secondly, as noted by the Deutsche Bank, the fiscal position has deteriorated substantially compared to the situation after the pandemic, limiting the available scope for extensive support measures (DB 2026d). Many of the measures are therefore implemented within current budgets and the mobilisation of additional funds is limited resulting in a more muted fiscal response overall (DB 2026c and 2026d).

Fiscal framework and scope

The more muted fiscal response is also due to the fiscal framework of the European Union. Although there is room for flexibility in exceptional situations, it is currently only being used to a limited extent.

Of central importance is the difference between the two flexibility mechanisms, the General Escape Clause (GEC) and the National Escape Clause (NEC). The GEC enables a more extensive deviation from the budgetary rules for all member states but requires a severe economic downturn on a European level. It was last activated during the Covid crisis but is currently not in force (DB 2026d). The NEC, in contrast, allows individual member states to temporarily deviate from the set expenditure path if exceptional circumstances significantly impact public finances. This instrument is therefore at the centre of current debate on creating additional fiscal scope.

In terms of practical application, the NEC is currently becoming more significant. It is already in use for defence expenditure and has enabled member states to increase their expenditure substantially in response to the changed geopolitical situation. More specifically, the current rules allow for member states to increase their defence expenditure up to around 1.5 percent of GDP per year up to 2028 without requiring any additional fiscal adjustment (DB 2026d). This illustrates that the existing fiscal framework provides for targeted exemptions without lifting the overall budgetary requirements

In view of the current energy shock, debate on a more extensive use of existing flexibility mechanisms has increased. There are calls for a broader application of the NEC and a possible activation of the GEC. The latter is currently still not very likely as the situation as it stands does not clearly meet the requirement of a severe overall economic downturn across the Euro area (DB 2026d).

At the same time, support for a more extensive easing of fiscal rules at European level is so far limited Although individual member states are calling for greater use of existing flexibility, the focus in the current environment is on the NEC. The resonance to such proposals has so far been subdued. The European Commission is standing by its policy to date and emphasises that fiscal measures should continue to be primarily temporary and limited. Given the persistent inflation-side risks, worries are that a broader and longer-term use of fiscal flexibility would create additional incentives for spending and could therefore also drive prices up (DB 2026d).

Overall, this means that the scope for fiscal measures is limited. Although the institutional framework does provide for deviations, their use remains selective and politically controversial. This is a central reason why the fiscal support in the current situation has been comparatively moderate.

Price development and monetary policy: Energy prices bring trade-offs to monetary policy

The energy price shock is presenting monetary policy in the Euro area with the challenging juggling act of stabilising prices, while also supporting the economy. Inflation has risen substantially most recently, while indications of an economic slowdown are mounting. The ECB is therefore following an explicitly data-dependent and meeting-by-meeting approach instead of pre-committing to a particular rate path (ECB 2026c).

Transmission of the energy price shock

The monetary policy response to the energy price shock is largely determined by the scale of the shock’s overall impact on price levels over various channels. The literature and market analyses differentiate between three mechanisms of transmission (DB Research 2026a):

▪ Direct effects: Rising energy prices impact the consumer price index directly (e.g fuels, electricity). These account for almost the whole of the current rise in inflation and largely follow mechanical correlations

▪ Indirect effects: With a time delay, companies pass the higher energy costs on to their customers. First indicators, such as rising input costs and selling price expectations in business surveys, show that these effects are already growing and that they could extend across industrial goods and services.

▪ Second-round effects: These result particularly through rising inflation expectations and wages and are decisive for monetary policy as they can perpetuate inflationary pressure. The ECB has so far not identified any clear indications of such effects but emphasises that they generally take some time to unfold.

The ECB is explicitly orientating its monetary policy strategy on this momentum. While direct effects can generally be ‘looked through’, pronounced indirect and particularly second-round effects require a considerably stronger monetary policy response.

Macroeconomic starting position and assessment by the ECB

The ECB emphasises that the Euro area was in a robust situation overall when the current shock hit. Inflation was close to target and the economy showed a certain level of resilience. At the same time, the framework conditions have deteriorated tangibly since the outbreak of the conflict. High energy prices are weighing on real disposable incomes and curbing consumption and investment, while uncertainty and weaker foreign demand are additionally impacting economic activity (ECB 2026c).

The financing conditions have also already become tighter, with rising risk premiums and more restrictive lending, partially pre-empting monetary tightening (DB Research 2026b), raising the question to what extent additional rate hikes are needed or if adequate tightening already unfolds over the financial markets.

The ECB Governing Council’s risk assessment has changed accordingly. The upside risks to inflation and the downside risks to growth have intensified and are no longer regarded as purely temporary (ECB 2026c). At the same time, there is considerable uncertainty as to the duration and scale of the

energy price shock and the transmission of the shock across the economy.

Results of the ECB meeting in April 2026

In this context, the ECB Council decided to leave the key interest rates unchanged (deposit facility rate: 2.0%) in its meeting on 30 April 2026 (ECB 2026c). This decision is not so much a sign of a stable monetary stance but represents a transitional phase in which the key influencing factors cannot yet be conclusively assessed.

▪ Decisive to the decision-making process is that the extent of the transmission of the shock remains unclear: The ECB is currently not focusing on the immediate trend in inflation but on identifying the scale and speed of the impact of the energy price shock across the breadth of the economy through indirect effects and potential second-round effects Although first indirect effects are becoming visible, there is so far no solid evidence that the inflationary pressure is becoming embedded, particularly through wages. The central factor of uncertainty is therefore not the scale of the current increase in prices but its momentum going forward (ECB 2026d).

▪ Rising significance of the next round of data and projections: The monetary policy focus is therefore explicitly on the next few weeks. The ECB is waiting for additional evidence on the development of inflation expectations, wage agreements and the pricing of companies to make conclusions on the extent of the transmission. The next meeting, which will also include updated staff projections, will play a decisive role in determining the monetary policy stance of the ECB. The appropriate monetary policy response can only be decided once there is a solid basis, even if it is incomplete, for assessing the inflation prospects. The impact across central transmission channels, particularly in relation to wages, only becomes visible after some time (ECB 2026d, DB Research 2026a).

Scenario-based classification of the monetary policy response

The ECB staff projections provide a structured framework for possible monetary policy responses:

▪ Baseline scenario: Here, inflation rises to 2.6 percent in 2026 before returning to target. In this case, the ECB will primarily try to prevent the de-anchoring of inflation expectations. This would call for moderate, cautious tightening as also implied by market-based interest rate expectations at the time of the ECB forecast (see ECB 2026b, DB 2026b). In view of the continued duration of the Iran conflict and that there is currently no end in sight, it is increasingly questionable whether the baseline scenario remains valid, especially considering that the ECB projections date from 11 March (cut-off). Instead, indications are mounting that the situation is shifting in the direction of the adverse scenario.

▪ Adverse scenario: According to the ECB, inflation in the adverse scenario would be 0.9 percentage points higher in 2026 and 0.1 percentage points higher in 2027 but 0.5 percentage points lower in 2028. At the same time, growth would be slightly lower (by 0.3 and 0.1 percentage points). The stronger energy price shock would amplify not only the short-term inflationary pressure but also the probability of indirect effects and possible secondround effects. This would generally require a tighter monetary policy stance than in the baseline scenario. At the same time, the lower growth and already more restrictive financing conditions would limit the scope for a more aggressive tightening making additional rate

changes more probable, but the scale of the hikes would depend on how pronounced the second-round effects turn out to be.

▪ Severe scenario: Inflation here would be 1.8 percentage points higher than in the baseline scenario in 2026, 2.8 percentage points higher in 2027 and 0.7 percentage points higher in 2028, while growth would be much lower and temporarily slightly negative. The sustained high energy price shock would lead to pronounced indirect effects and considerable second-round effects which would generally call for a substantially more restrictive monetary policy than in the baseline scenario However, if economic activity takes a deep plunge at the same time, growth risks may well predominate. The resulting weakness in demand would curb inflationary pressure in the medium term, which is the decisive horizon for the ECB. In this case, the ECB may ease its monetary policy despite initially higher inflation in an effort to counteract the downward economic momentum.

Classification

The monetary policy response is thus decisively dependent on the scale and extent of the transmission of the energy price shock going forward and the impact on medium-term inflation. In case of limited and mainly direct effects, a moderate and phased stance would be appropriate, while a broader transmission of the shock through indirect and second-round effects would significantly increase the pressure for a greater monetary policy response.

The scenario analysis also shows that the monetary policy response is not linear. The greater the intensity of the shock, the more difficult the balancing act between the conflicting objectives of combating inflation and stabilising the economy. Moderate scenarios can call for a greater tightening to stabilise inflation expectations, in a severe scenario with a strong economic slump the monetary policy response can turn around. In this case, growth risks predominate and require monetary easing despite higher inflation as the weak level of demand would curb the pressure on prices in the medium term.

Financing conditions: Geopolitical tensions cause slight tightening

The financing conditions in the Euro area have deteriorated somewhat since our last forecast in December. In the baseline scenario of the ECB, they are still generally assessed as supporting the economy but have become temporarily less favourable particularly due to the geopolitical tensions (ECB 2026b,c). The interest rate for market-based debt financing had increased tangibly at last count.

The tightening is more visible in bank lending. The lending standards for corporate loans were tightened again in the first quarter 2026 (net up 10 %), while demand for loans dropped slightly (net down 2%). Trends for households were mixed with conditions for house purchase loans only slightly more stringent, while consumer loans were tangibly more restrictive and demand also decreased

In its scenario analysis, the ECB (2026b) also highlights that an escalation of the conflict in the Middle East could raise uncertainty therefore leading to higher risk premiums, lower stock prices and rising financing costs for banks and companies, thus additionally tightening financing conditions.

Such mechanisms were in fact visible on the financial markets following the escalation of the Iran conflict. In early March, the markets responded with a clear risk-off movement. Stock prices dropped

tangibly, while government bond yields increased initially. In the following weeks, the situation eased slightly spurred by hopes of a ceasefire, diplomatic progress and a stabilisation of the energy supply Stock markets correspondingly recovered in part. The bonds market also displayed a counter movement but on a small scale

10-year government bond yield, in percent

Source: Macrobond

Labour market: Stable with flagging momentum

Despite the subdued economic environment, the labour market in the Euro area has remained relatively stable. In March 2026, seasonally adjusted unemployment was slightly down year on year at 6.2 percent The number of unemployed people was also lower year on year. Compared to March 2025, around 170,000 less people were unemployed. At the same time, youth unemployment remained clearly elevated at 14.9 percent (Eurostat 2026).

ECB projections (2026b) indicate that the momentum on the labour market is set to weaken further during the period under review. After several years of a solid upward trend in employment, growth slowed down in 2025 and is expected to weaken further in the next few years. After rising 0.7 percent in 2025, the growth in employment is expected to drop to around 0.5 percent in 2026 on account of the diminished economic momentum in the Euro area. At the same time, the ECB predicts that companies will generally tend to keep workers (‘labour hoarding’) in view of the expected temporary nature of the economic downturn. However, this effect is likely to be limited by rising cost pressures and the resulting pressure on profits.

In this context, the unemployment rate is likely to first continue to rise slightly, before turning down again in 2027. On an annual average, it will remain largely stable and be at around 6.3 percent between 2025 and 2027 before falling slightly, down to around 6.2 percent in 2028 (ECB 2026b). Despite the stable development overall, considerable differences remain between the individual member states, with very low unemployment rates in some Central and Eastern European countries such as Poland

and the Czech Republic and comparatively low levels in Germany, for example. Other countries, on the other hand, particularly Spain and Greece, continue to have high rates of structural unemployment.

Unemployment rate* in the Euro area, in percent

adjusted

Sources: Macrobond, Eurostat

Risk analysis

Despite individual stabilising developments, such as progress in international trade talks and fiscal measures to support growth in individual member states, the economic environment in the Euro area continues to be marked by high uncertainty. Geopolitical tensions, trade policy risks and continuing vulnerabilities on the financial markets are still weighing on economic development The following risks and opportunities could therefore lead to divergencies to the forecast economic trends. Risks related to the Iran conflict are not addressed separately as they have already been analysed above in a separate scenario analysis.

Downside risks

▪ Trade disputes and uncertainties: The current development in the transatlantic trade dispute clearly shows the continued high uncertainty regarding future trade policy The structure of US tariff policy after the termination of the temporary measures and set time limitations is particularly unclear, for example in relation to the currently effective base tariff rates. This continuing uncertainty is already curbing economic momentum. Empirical analyses show that trade policy uncertainty prompts companies to wait and see, thereby postponing investments and adjusting international value chains. This can tangibly dampen investment and export momentum, particularly in the Euro area on account of its strong focus on exports. China’s economic development and trade policy also represents a major risk factor. Weaker domestic demand in China and rising export surpluses can both dampen demand for European goods and substantially increase the competitive pressure on the European internal market and on third markets

▪ Financial market risks and systematic vulnerabilities: While the development on international financial markets has so far been robust despite the heightened volatility caused by geopolitical uncertainties, significant vulnerabilities remain. The high valuations on the capital markets, increasingly concentrated on technology and AI-driven companies, harbour particularly high risks. A new valuation of these expectations could lead to abrupt price corrections which could also affect the Euro area through asset and confidence effects and tighter financing conditions. Structural risks also remain in relation to non-bank financial intermediaries. Liquidity discrepancies, higher debt and increasingly close ties with the banking system could intensify market upheavals during phases of stress while limited transparency additionally impedes risk assessment. Rising interest and refinancing risks increase the pressure on highly indebted states and private players and can weigh on investment and growth prospects. Crypto-based financial innovations also still represent a risk factor as stress situations, particularly in the case of stablecoins, can lead to market tensions on money and bond markets.

▪ Consumption and investment risks: Decreasing real incomes in the wake of the Iran war and rising goods prices is continuing to subdue consumption momentum in the Euro area Another major factor keeping consumption down is the persistently high level of uncertainty, particularly in relation to geopolitical and trade policy risks, which is making private households cautious and increasing their propensity to save money. Empirical analyses show that uncertainty makes households and businesses postpone or completely suspend consumption and investment decisions. There is a risk that inflation expectations become de-anchored and second-round effects lead to sustained higher inflation. In this case, a more restrictive monetary policy stance may be required. On account of the time lag in the transmission of monetary policy, the real economic effects would primarily unfold in the medium term. Furthermore, the investment momentum could also be weighed down by possible corrections in technology-driven investment cycles. A new evaluation of expectations regarding AI-based productivity gains, in particular, could lead to a decrease in related investments and additionally weaken economic momentum.

Growth opportunities

▪ Higher productivity gains through AI: A swifter diffusion of AI than expected so far could considerably increase productivity, thereby leading to earlier and higher growth than assumed in the baseline scenario. Especially the current increase in AI-related investment and the rising application of AI in different sectors could create short and medium-term growth impetus. However, this development would need to be accompanied by supporting measures, such as ensuring an adequate supply of energy, the availability of necessary inputs and the support of adjustment processes on the labour market. Without these framework conditions, the positive effects could remain limited or be distributed unequally

▪ Acceleration of structural reforms: Structural reforms harbour large upward potential in view of the current challenges and technological upheavals. The resolute implementation of measures to reduce regulatory barriers, strengthen competition, innovation and the qualification of workers and lift labour mobility could sustainably raise the growth potential. At the same time, such reforms also improve the adaptability and resilience of economies. Model calculations of the IMF (2026) show that an extensive package of reforms in major economies could increase global growth in the short term by more than 0.5 percentage points.

▪ Reduction of trade barriers and expansion of multilateral cooperation: Progress in international trade talks could considerably strengthen global economic activity by lowering tariffs and raising planning certainty. More predictable economic policy would facilitate investments and get projects that have been postponed back on track. Additional growth impetus can be unleashed if cooperation goes beyond the trade of goods to incorporate services, direct investments and international tax issues. New and deeper trade agreements can lower trade costs and facilitate adjustment processes.

▪ Greater resilience and adaptability on the internal market: Companies could prove to be more resilient and adaptable than currently assumed. In the past, they have already shown considerable adaptability in the face of higher trade barriers, rising inflation and exacerbated labour shortages. This adaptability, for example through restructuring supply chains and business processes, could help to cushion the negative effects of geopolitical shocks to a greater extent than assumed in the baseline scenario.

Outlook and economic policy recommendations

In view of the economic slowdown, heightened uncertainty and structural challenges set out above, the economic environment of the Euro area is in an altogether fragile state. The short-term development is largely marked by external shocks and their transmission through energy prices, financing conditions and expectations, while the medium-term growth prospects remain limited on account of the continuing structural weaknesses.

The implications of the overall situation for economic policy are clear. Alongside a stability-oriented response to short-term pressures, the need for a targeted improvement of structural framework conditions to encourage growth, investment and adaptability is becoming increasingly apparent, making the economic policy agenda all the more important.

Action is urgently needed to secure the economic growth of the Euro area for the long term, with a resolute and greatly accelerated implementation of targeted measures to strengthen competitiveness, mobilise investments and raise economic resilience. The most recent developments have significantly increased the need for an ambitious economic policy, particularly the high and volatile energy prices, the continuing supply uncertainties in the wake of the conflict in the Middle East, persistent high trade policy uncertainty in transatlantic trade and structural weaknesses within individual member states. The key challenges and options for reforms have long been clearly set out, for example in the reports of Mario Draghi and Enrico Letta, the EU Compass for Competitiveness and the Clean Industrial Deal, but resolute implementation has not taken place so far. In the increasingly strained global environment, Europe is in danger of losing more economic substance and competitiveness. It is therefore crucially important that concrete progress is finally achieved. The following points set out what we believe are currently the most urgent and important fields of action in economic policy

▪ Deepening the internal market, particularly in the areas of services, energy and digitalisation: A more deeply integrated internal market is of crucial importance to increase the productivity, economic resilience and global competitiveness of Europe. This includes the rapid expansion of cross-border energy and digital infrastructure and the reduction of remaining regulatory and administrative barriers, particularly in the service sector. Analyses of the ECB (2025b) and the IMF (2024) show that trade costs within Europe are high overall on an international comparison, and especially in services. These structural barriers constrict

competition and make economic activity more expensive and should therefore be resolutely reduced.

▪ Advancing structural reform at EU and national level: A greatly accelerated implementation of structural reforms is needed to sustainably strengthen growth potential. At the EU level, this especially entails the reduction of regulatory complexity with a tangible reduction in administrative burdens and the deepening of the Savings and Investment Union to facilitate cross-border investment and reduce fragmentation. Reforms needed at the national level include reforms of labour and product markets, reforms to modernise state structures and the consequent reduction of investment barriers. The accelerated pace of technological transformation increases the significance of the diffusion of new technologies, particularly artificial intelligence, necessitating reliable framework conditions that encourage innovation.

▪ Improving investment conditions and strategically deploying EU funds: Europe faces a considerable investment gap of more than 1.2 trillion euros per year, particularly in relation to the energy and network infrastructure, digitalisation, industrial transformation, resilience and defence. Sustainably securing competitiveness and the strategic capacity to act will require a greater mobilisation and more targeted deployment of private and public investment, especially to strengthen research and innovation. The EU’s Multiannual Financial Framework (MFF) 2028-2034 should be firmly focused on increasing the impact of investments, pooling and simplifying programmes, including the further development of existing instruments such as InvestEU and IPCEIs, and the targeted structuring and implementation of the European Competitiveness Fund (ECF). Decisive factors here are also reliable regulatory framework conditions, planning certainty and making Europe an internationally competitive production and business location to enable faster and more effective investment across Europe. At the same time, the quality of investments is becoming more important. Public funds should be more focused on measures that increase productivity to make efficient use of the narrow fiscal scope available.

▪ Securing open markets by strategically developing trade relations: The EU should resolutely advance the conclusion of further trade agreements and firmly implement existing agreements. Diversified supply chains, improved market access and reliable framework conditions for trade and investments are key preconditions for economic resilience. At the same time, a coordinated European strategy is needed to better tackle trade diversions, surplus capacities and subsidies that distort competition. In this way, Europe can secure its competitiveness and assert its interests in the increasingly fragmented and protectionist global economy.

▪ Structuring the fiscal policy response to shocks towards stability: Fiscal measures should be targeted, temporary and growth-oriented in their structure to cushion economic shocks, particularly supply shocks caused by rising energy prices, without intensifying inflationary impetus or counteracting monetary policy measures In an environment of heightened inflation caution is required. Broad measures that lift demand should be avoided as they can increase price pressure and interest rates. Support measures should be limited to the hardest hit households and companies with clear time limitations and should preserve price signals. Considering the limited fiscal scope, measures should be resolutely prioritised and aligned with medium-term fiscal objectives.

▪ Carefully calibrating monetary policy between inflation and growth risks: Energy price shocks primarily take the form of supply shocks, increasing inflation in the short term, while also curbing economic growth. More consequential than the direct increase in prices is the danger of rising inflation expectations and the resulting second-round effects. If these become embedded, they can lead to a more restrictive monetary policy which additionally curbs economic momentum. If inflation expectations remain stable, it is easier for monetary policy to look through the temporary price shock. A careful balance is therefore required between price stability and growth that takes account of the situation as it evolves (see OECD 2026; IMF 2026).

▪ Aligning energy policy towards resilience and competitiveness: Central to this is the need to restore balance to the energy sector’s ‘triangle of objectives’: ‘security of supply –competitiveness – sustainability’. This means that the expansion of renewable energies must be carried out in a manner that is more compatible with the grid, security of supply must be maintained, and internationally competitive price levels must be restored, particularly for electricity and gas. At the same time, diversifying the energy supply and utilising domestic, climate-friendly energy sources are important for increasing security of supply and reducing dependence on imports. Greater international coordination also helps to make the best possible use of the potential of the European internal energy market.

Sources

Banco de España (2026). Macroeconomic projections and quarterly report on the Spanish economy. March. Madrid.

Banque de France (2026). Macroeconomic interim projections. March. Paris.

Banca D’Italia (2026). Macroeconomic projections for the Italian Economy. April. Rom.

Bruegel (2026). 2026 European energy crisis fiscal response tracker. May. Brussels.

Destatis (2026). Bruttoinlandsprodukt im 1. Quartal 2026 um 0,3 % höher als im Vorquartal Pressemitteilung Nr. 153. April. Wiesbaden.

Deutsche Bank Research (2026a). Passthrough Playbook: Tracking the stages of energy transmission. Economics Europe Blog. May. Frankfurt am Main.

--(2026b). ECB Reaction: A rapidly narrowing window to avoid hikes. Economics Europe Blog. April Frankfurt am Main.

--(2026c). Iran shock and fiscal shielding: an update. Economics Europe Blog. April. Frankfurt am Main.

--(2026d). Iran Shock and the case for an Energy National Escape Clause. Economics Europe Blog. May. Frankfurt am Main.

--(2026e). France - A weakening economy in May, but not THAT weak. Economics Europe Blog. May Frankfurt am Main.

European Central Bank (2026a). Monetary Policy Statement Press Conference. April. Frankfurt am Main.

--(2026b). ECB staff macroeconomic projections for the Euro area. March. Frankfurt am Main.

--(2026c). Combined monetary policy decisions and statement April. Frankfurt am Main.

(2026d). Monetary Policy Statement. Press Conference Christine Lagarde, President of the ECB, Luis de Guindos, Vice-President of the ECB April. Frankfurt am Main.

(2025a). Staff macroeconomic projections for the Euro area September. Frankfurt am Main.

--(2025b). What is the untapped potential of the EU Single Market? Frankfurt.

Eurostat (2026). Unemployment statistics. March. Luxembourg.

Instituto Nacional de Estadística (2026). Quarterly National Spanish Accounts. First quarter 2026. Provisional. April. Madrid.

Istat (2026). Preliminary estimate of GDP - Q1 2026. April. Rom.

International Monetary Fund (2026). World Economic Outlook. Global Economy in the Shadow of War. April. Washington D.C.

--(2024). Europe's Choice: Policies for Growth and Resilience. December. Washington, D.C.

OECD (2026). OECD Economic Outlook, Interim Report. March. Paris.

S&P Global (2026a). Global Eurozone Composite PMI May. New York City.

--(2026b). Global Flash France PMI. May. New York City. (2026c). Global Flash Germany PMI. May. New York City.

Imprint

Federation of German Industries e.V. (BDI)

Breite Straße 29 10178 Berlin

T: +49 30 2028-0 www.bdi.eu

German Lobbyregister Number R000534

Author

Frederik Lange

T: +49 30 2028 1734 f.lange@bdi.eu

Editorial / Graphics

Dr. Klaus Günter Deutsch T: +49 30 2028 1591 k.deutsch@bdi.eu

Marta Gancarek

T: +49 30 2028 1588 m.gancarek@bdi.eu

This report is a translation based on „Wachstumsausblick Europa – Mai 2026, Energiepreisschock belastet das Wachstum im Euroraum“, as of 27 May 2026.