EU Economy: Weekly Commentary – May 25, 2026

European Market Review

Eurozone yields fell. Spreads widened. Equities rose, led by Germany. The euro weakened slightly. Brent crude dropped on US–Iran negotiation optimism and lower risk premiums.

Last week, Eurozone sovereign bond yields declined sharply. The German–French 10-year spread stood at 79.5 basis points. The German–Italian spread reached 73.8 basis points, widening by 5.6 basis points over the past month. Equity markets ended the week in positive territory. Germany led gains with an increase of nearly 4%. The euro weakened by 0.21% against the US dollar. In commodities, Brent crude fell by 7.83%. This decline was driven by expectations of progress in US–Iran negotiations, which reduced geopolitical risk premiums and improved prospects for supply stability, particularly in the Strait of Hormuz.

Europe View Synopsis

Eurozone growth is cut to 0.9% as war-driven energy costs raise inflation to 3%, weakening demand, raising debt risks, and increasing recession concerns across Europe.

The European Commission has downgraded Eurozone growth to 0.9% this year, down from 1.4% in 2025, as the war in the Middle East pushes up energy prices, disrupts supply chains, and increases inflation to 3%. The higher cost of oil and gas is straining households, businesses, and government budgets, while broader challenges such as weak productivity, trade tensions, and global competition continue to weigh on the recovery. Growth is expected to remain subdued at 1.2% in 2027, with debt levels rising above 90% of GDP, adding fiscal pressure. Economic performance is uneven across countries, with Germany forecast at 0.6%, France at 0.8%, Italy at 0.5%, and Ireland expected to contract. Business surveys confirm weakening momentum, with the Eurozone PMI falling to 47.5, signalling declining output, demand, and confidence across manufacturing and services. Although Germany posted a short-term 0.3% quarterly rebound driven by exports and public spending, underlying domestic demand remains weak, and the overall outlook points to slower growth, persistent inflation, and rising recession risks across the region.

EU Economic Forecast

EU cuts Eurozone growth to 0.9% as Iran war drives energy prices. Inflation rises to 3%. Major economies weaken. Debt and recession risks increase.

The European Commission has revised down its economic outlook for the Eurozone, now forecasting growth of just 0.9% this year, compared with 1.4% in 2025 and an earlier estimate of 1.2%, as the war in Iran fuels higher energy prices, disrupts global supply chains, and intensifies inflationary pressures across the bloc. Inflation is expected to rise to 3% this year, up from 2.1% last year and above the Commission’s previous forecast of 1.9%, driven largely by surging oil and gas costs that are increasing expenses for households and industry while forcing governments to extend support measures to shield their economies. The Commission warned that the conflict represents a significant energy shock for Europe at a time when growth is already weak, with ongoing structural challenges including low productivity, trade tensions with the United States, and competitive pressure from Chinese manufacturers continuing to weigh on the region’s recovery. Growth projections for 2027 have also been cut to 1.2%, reflecting expectations of only a modest medium-term rebound.

The outlook varies across major economies, with Germany expected to grow by just 0.6% this year, Italy by 0.5%, and France by 0.8%, while Ireland is projected to be the only EU economy to contract, with output falling by 1.2%. The Commission also highlighted rising fiscal pressures, projecting that the Eurozone’s debt-to-GDP ratio will increase to 90.2% this year and 91.2% by 2027, with Italy expected to overtake Greece as the most indebted member state by 2027. EU economy commissioner Valdis Dombrovskis said the Middle East conflict has created a major energy shock that is testing Europe’s resilience in an already volatile geopolitical and trade environment, and warned that under a more adverse scenario involving sustained disruptions to energy flows, including risks around the Strait of Hormuz, growth could be significantly weaker and inflation higher. The European Central Bank has outlined a similar baseline outlook but has also cautioned that in a more severe scenario, oil prices could spike sharply and growth could fall further, underscoring rising concerns about recession risks as recent survey data shows business activity in key economies such as France falling to its lowest level in more than five years.

We don’t expect rate cuts this year. Inflation is rising to 3% from higher energy prices, while growth slows to 0.9%, keeping the ECB on hold as risks remain tilted toward price pressures.

Business Activity

Eurozone PMI fell to 47.5 in May, signalling broad weakness in activity, falling demand, rising costs, and growing recession risks if Middle East tensions persist.

The Middle East conflict weighed more heavily on Eurozone business activity in May, intensifying concerns over both growth and inflation. The headline PMI fell from 48.8 in April to 47.5, its lowest level since 2023, with manufacturing activity easing to 51.4 (vs. 51.7 expected, 52.2 prior) and services deteriorating sharply to 46.4 (vs. 47.8 expected, 47.6 prior), marking a 63-month low. The composite PMI dropped to a 31-month low, pointing strongly to a contraction in Eurozone GDP in the second quarter and increasing the risk of a technical recession if the conflict persists, with France acting as the main drag among major economies. While markets remain focused on the inflationary effects of the war, the PMI data underscores that the hit to growth is becoming increasingly difficult to ignore, as output weakens and new orders and employment decline across the region. Businesses are facing a combination of sharply rising input costs, worsening supply chain disruptions, and weak confidence among firms and consumers, resulting in falling demand across both services and manufacturing. In services, new orders recorded their steepest decline in 18 months, while the earlier boost from inventory accumulation in manufacturing is beginning to fade. Although input cost inflation accelerated for a seventh consecutive month and selling prices rose at the fastest pace in 38 months, weaker demand is making it harder for firms to pass higher costs on to consumers, putting pressure on corporate margins and distinguishing this shock from 2022, when stronger demand and government support cushioned the impact. With no comparable fiscal support measures in place and no post-pandemic reopening boost to services, the Eurozone appears more vulnerable to a prolonged energy shock, raising the risk of a more pronounced slowdown if geopolitical tensions remain unresolved.

We expect Eurozone growth to slow further as the Middle East conflict sustains cost pressures and weakens demand, keeping activity under pressure through Q2.

German GDP

Germany’s economy grew 0.3% QoQ in Q1 2026, driven by exports and public spending. Private consumption was flat QoQ. Investment was weak. Inventories dragged growth. Outlook remains uncertain.

Germany’s economy grew by 0.3% QoQ in Q1 2026, its strongest quarterly performance since early 2025, showing resilience despite ongoing uncertainty linked to the war in the Middle East. Growth was mainly supported by a sharp rise in exports and higher public consumption. Private consumption was unchanged QoQ, reflecting continued household caution amid high inflation pressures and elevated interest rates. Private investment remained weak, particularly in construction, which continues to struggle with high financing costs, lower demand, and subdued building activity.

On the external side, exports increased by 3.3% QoQ after declining in Q4 2025, while imports rose only 0.1% QoQ . This resulted in a strong positive net trade contribution of 1.3 percentage points to GDP growth, making foreign demand the main driver of growth in Q1. However, this was partly offset by a sharp drawdown in inventories, which subtracted 0.9 percentage points from GDP growth, highlighting volatility in stockbuilding and suggesting that part of the export strength may not fully reflect underlying domestic momentum.

Looking ahead, the outlook is more fragile. Net exports are unlikely to repeat such a strong contribution in Q2 due to rising geopolitical risks, higher energy prices, and potential supply chain disruptions. Private consumption is expected to remain weak QoQ as real incomes stay under pressure and financing conditions remain tight. Construction activity is also likely to stay subdued given high borrowing costs. This leaves public sector spending as one of the few stable sources of support for growth in the near term.

We expect that Germany’s economy will slow in the coming quarters as export support fades and domestic demand remains weak. Growth is likely to stay subdued and uneven.