- Euro-area growth in 2026 is expected to be steady but modest (about 1.2%–1.4%), supported by fiscal stimulus and resilient domestic demand.
- Inflation is easing toward the ECB’s 2% target, though services and core pressures remain key watchpoints.
- The ECB is likely to keep policy rates near neutral, while long-term yields face upward pressure from higher sovereign issuance and quantitative tightening.
- Optimism for European capital markets rests on tight credit spreads and strong corporate bond issuance, but high valuations and banking/private-credit linkages pose downside risks.
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Recent macroeconomic data reinforce an outlook of moderate but stable growth for the euro area heading into 2026. The ECB’s December projections estimate real GDP growth of approximately 1.2% in 2026 (up from earlier lower forecasts), with stronger outcomes in 2027–28 thanks to accelerating government investment and foreign demand. The European Commission similarly expects output growth of about 1.2% in 2026. Inflation has eased, with headline HICP declining from ~2.1% in 2025 toward ~1.9% in 2026, and core inflation gradually converging toward target levels amid easing wage and non-energy goods pressures.
Monetary policy appears firmly set in a “wait-and-see” phase. Short-term rates have been held steady around current levels, viewed as approximately neutral given the ECB’s estimates of the natural rate being between –0.5% and 1%, and minimal risk of further cuts unless inflation or growth deviate significantly. Long-term interest rates face upward pressure from several structural dynamics: increased sovereign issuance to fund expanded fiscal and defense spending; shift in pension schemes from defined benefit to defined contribution reducing long-dated bond demand; and continued ECB quantitative tightening.
Capital markets may benefit from tighter credit spreads, bolstered issuance activity (particularly in the EUR corporate bond market, where forecasts anticipate record supply in 2026), and stable funding costs under neutral short-term rates. However, market valuations are high, volatility subdued (despite real macro, geopolitical, and policy risks), and the banking sector’s exposure to private credit and synthetic risk transfer structures poses potential channels for risk transmission.
The strategic implications for investors, corporates, and policymakers include: the need to position for rising long yields, monitor sovereign financing risks, scale risk management around volatility in bond markets, weigh defense and infrastructure policy impacts, and track regulatory developments (e.g., pension reforms, synthetic securitisation oversight). Open questions remain around how durable inflation deceleration will be (especially services), whether rate stability holds if shocks emerge, and how external trade policy friction will evolve.
Supporting Notes
- ECB Euro-area real GDP growth is projected at ~1.2% in 2026, up from ~1.0% in prior projections; 2025 growth is expected at ~1.4%.
- Headline inflation (HICP) is projected to fall from ~2.1% in 2025 to ~1.9% in 2026; HICP excluding energy and food to decline from ~2.4% in 2025 to ~2.2% in 2026.
- ECB estimates natural rate of interest in euro area between –0.5% and 1%, implying current policy rates are approximately neutral with real rates near zero if inflation ~2.1%.
- German inflation in December 2025 fell to ~2.0% year-on-year; core inflation also eased from ~2.7% to ~2.4%.
- Corporate bond issuance in EUR projected to hit €485 billion in 2026, a record, though net supply remains stable due to rising redemptions (~€304 billion).
- Sovereign deficits rising: ECB projects euro-area budget deficit increasing from ~3.1% of GDP (2024) to ~3.3% in 2026; debt-to-GDP ratio also trending upward.
- Risks flagged: elevated equity valuations, subdued volatility; banks’ exposure to private credit and synthetic risk transfers, with systemic financial stability concerns from interlinkages.