The Conference Board Economic Forecast for the Euro Area Economy

Manufacturing shows first signs of fragility. In our September update, we showed that manufacturing and exports helped the Euro Area (EA) economy expand in H1, despite the war in Iran and the energy shock it triggered. The key question we posed was whether this could last into H2, given weak underlying conditions. Recent data, now, suggest manufacturing momentum is fading. Industrial output in France fell to a four-month low, in Germany to a new post-2019 low, and Italy’s to its lowest level since late 2025. Exports have also lost their H1 strength, plateauing or edging down across Europe’s three largest economies. Meanwhile, the headwinds are building up. Summer heatwaves disrupted supply chains, energy prices, especially gas, keep rising, and competition from China continues to add pressure on manufacturers. Survey indicators still point to resilient confidence among EU industrialists, suggesting a modest slowdown in Q3 and Q4 rather than a steep decline. But as one of the region’s key drivers of growth loses steam, growth in H2 will most likely fall short of H1.

Economic resilience continues, but on a tightrope. Beyond manufacturing, fresh signs of weakness are emerging across other pockets of the economy. Our standardized consumer-confidence index fell again in September after several months of improvement, as higher inflation erodes real wage gains and concerns over prices and unemployment weigh on households. Fixed investment, the only expenditure component to subtract from quarterly growth in H1 2026, is unlikely to regain much momentum late this year: uncertainty continues to delay business decisions, while tighter monetary policy keeps borrowing costs elevated. The ECB’s latest bank lending survey points to a recovery in loan demand expectations in Q3, but credit standards remain tight. Public spending provides a partial offset, supported by higher defense expenditure and defense-related manufacturing, but it is too small to compensate fully for softer private demand. Taken together, the economy appears headed for contained deceleration into the end of the year. We therefore leave our 2026 EA growth forecast unchanged at 1.2% but lower our 2027 forecast to the same rate. A weaker hand-off from 2026, combined with renewed energy price pressures and deteriorating confidence, will weigh more visibly on activity next year.

Price pressures increase, and… broaden. September’s inflation reading surprised on the upside. Headline inflation rose from 3.2% in August to 3.8% year on year, driven primarily by a renewed surge in energy prices, up 19%. But the increase was no longer confined to energy: food inflation accelerated to 1.4% and services inflation to 3.24%, while goods inflation eased only marginally to 1.15%, still its second-highest rate since July 2024. This broader pressure will not sit comfortably with the ECB, which has already lifted its deposit rate to 2.5%. A second consecutive rate increase in October remains unlikely, however, because one month of data does not establish that the energy shock is creating persistent second-round effects in underlying inflation. The risk is growing, nonetheless. With energy prices likely to remain elevated and negotiated wage growth having strengthened in recent months (from 1.9 to around 2.5 year-on-year), the ECB may need to act more decisively in December to prevent a more durable wage-price dynamic from taking hold, even at the cost of further weakening activity. We now expect an additional 25bp rate increase in 2026, bringing the terminal rate to 2.75% rather than the 2.50% we projected a month ago. Thereafter, we expect only gradual easing in 2027, assuming inflation returns to target on a sustained, albeit slower-than-expected basis.

The labor market continues to cool, but gradually and unevenly across countries. Latest data point to a further moderation in labor-market conditions. The bloc’s unemployment rate was unchanged at 6.4% in August, but the aggregate masks divergent national developments. Germany’s jobless rate rose to 4.0%, its highest level in more than a decade. By contrast, unemployment fell in France, from 8.4% in June to 8.2% in August, it was unchanged in Spain at 10.0% and edged up in Italy to 6.2% from 5.5% in May. Forward-looking survey indicators have signaled weaker employment expectations for some time, suggesting that the cooling is likely to continue over the coming months. That said, we do not expect a material rise in EA unemployment as firms continue to remain cautious about shedding workers after years of labor shortages.

Risks to the outlook:

• Russia–Ukraine developments could trigger a fresh deterioration in EU–US relations (downside): Reduced US support for Ukraine, including restrictions on satellite access and uncertainty over intelligence-sharing, raises the risk of a longer war. The collapse of the proposed “energy ceasefire” within a day of its announcement reinforces that risk. More immediately, however, a more openly divergent US approach to Russia and Ukraine could become a new source of friction with Europe, opening the door to renewed trade and wider economic pressures at an already delicate moment for transatlantic relations.
• French unrest deepens confidence and financial-market pressure (downside): Past French social movements have generally had a limited and temporary effect on measured activity, concentrated in retail, transport and tourism. Confidence remains the largest risk. Protests make an already difficult fiscal adjustment more politically challenging and add to uncertainty over the 2027 budget. The yield on France’s 10-year yield rose by more than 14 basis points (bp) to approximately 4.93% between October 17^th and 19^th. Higher French borrowing costs in the wake of protests further tighten financial conditions for firms and households, delaying investments and hurting an already very weak domestic demand.
• Defense spending could deliver a stronger fiscal boost, though its scale will vary across different EA countries (upside): Rising military expenditure is increasingly sustaining public demand and feeding into manufacturing and trade. Production of arms and ammunition, a core defense-item, has accelerated since 2023, while both intra-EU and extra-EU exports have risen sharply, signaling that higher defense budgets are translating into real activity. The fiscal impulse should strengthen into 2027 as procurement plans are implemented and defense-related investment expands. Military expenditure has also increased as a share of government spending across Germany, Italy, Spain and Poland, underlining that this is a broad-based rather than country-specific trend. Faster implementation of national procurement plans, and a greater share of spending directed towards European production, would provide further upside to the euro area growth outlook.
• The EU–China understanding lowers escalation risk but does not alter the near-term trade outlook (mixed). The October “understanding” on hybrid vehicles reduces the immediate risk of a damaging trade escalation at a time when Europe would be more exposed than China. But it addresses only a narrow part of the bilateral imbalance, while the broader trade deficit and Chinese competitive pressure across strategic sectors remain. The Franco-German push for stronger trade defense and diversification tools signals a more serious European response, but it is unlikely to reduce Chinese imports materially in the near term. Lower production costs, state support and cheaper energy in China will continue to weigh on European producers.