The European Commission on Thursday revised its growth outlook for the eurozone, cutting the projected expansion for 2026 to 0.9% from a prior estimate of 1.2%. This downgrade follows expectations that the economy will expand by 1.3% in 2025 and reach 1.2% in 2027.
Officials attributed the weaker near-term outlook to an energy shock linked to the Iran war, which continues to exert pressure on European economic activity. The Commission highlighted the impact of higher energy costs on output and noted that these same price pressures are contributing to persistent inflation across the monetary union.
European Economy Commissioner Valdis Dombrovskis cautioned that under a more adverse scenario - in which energy prices do not peak until late 2026 - the Commission's growth projections could be roughly halved. That warning points to a materially weaker outcome if energy market stresses persist longer than currently assumed.
Inflation remains elevated in the eurozone. Official data released Wednesday showed annual inflation at 3.0% in April, above the European Central Bank's 2.0% target. The coexistence of slower growth and above-target inflation complicates the policy trade-offs facing European policymakers.
The ECB held interest rates steady late last month, but most market participants and analysts expect a rate increase in June. That anticipated move raises questions about the medium-term path of policy - in particular whether a weaker economy after a June hike would prompt the central bank to pause further tightening.
Andrew Kenningham of Capital Economics said the recent data would not dissuade the ECB Governing Council from a 25 basis-point increase in June, and he added that it would not alleviate concerns about recession risks. His assessment underscores the tension between the central bank's inflation objective and downside growth risks triggered by the energy shock.
Context and outlook
The Commission's updated numbers paint a picture of subdued momentum through 2026, with the energy situation identified as the primary downside risk. While a modest recovery to 1.2% is expected in 2027 under the Commission's baseline, officials signaled that outcomes are highly sensitive to future energy-price dynamics.
Implications for markets and policymakers
- Policymakers must weigh inflation that remains above target against a softer growth backdrop.
- Central bank decisions in coming months will be closely watched for signs of whether rate hikes proceed or are paused if economic conditions deteriorate further.