The EU economy defies gloom, but hardly inspires euphoria.
For an economy that spent much of the past three years staggering from one crisis to another, Europe’s performance in 2025 has been surprisingly robust. The European Commission’s autumn forecast, published on November 17, reveals that GDP growth in the first nine months exceeded expectations. Real output in the EU is projected to expand by 1.4 per cent this year and next, edging up to 1.5 per cent in 2027. The euro zone will track slightly below, at 1.3 per cent in 2025, 1.2 per cent in 2026, and 1.4 per cent in 2027.
These are hardly spectacular figures. Yet they represent a notable resilience in the face of what Valdis Dombrovskis, the European commissioner for economy, calls “a challenging external environment”. The continent has weathered Donald Trump’s tariff onslaught—now at their highest levels in nearly a century—better than many had feared. Indeed, the early-year surge reflected firms rushing exports to America ahead of anticipated duties. But the momentum has proved more than merely front-loaded; investment in equipment and intangibles has also outperformed, particularly in Ireland but elsewhere too.
Several factors underpin this modest expansion. Labour markets remain tight, with unemployment projected to edge down from 5.9 per cent this year to 5.8 per cent by 2027. Inflation continues its descent, forecast to hover around the European Central Bank’s two per cent target throughout the period ahead. Financing conditions have turned favourable. And the Recovery and Resilience Facility, the EU’s post-pandemic investment scheme, continues to cushion the blow from tighter fiscal policy across member states.
Nevertheless, the picture is far from uniformly rosy. Potential growth is declining as Europe’s working-age population shrinks—from 1.5 per cent last year to 1.3 per cent by 2027 in the EU, and from 1.4 per cent to 1.2 per cent in the euro zone. Public finances are deteriorating steadily. The EU’s general-government deficit is set to rise from 3.1 per cent of GDP in 2024 to 3.4 per cent in 2027, driven by climbing defence spending (from 1.5 per cent to two per cent of GDP), rising interest costs, and revenue shortfalls. Public debt will climb from 82 per cent to 85 per cent of GDP over the same period. By 2027, a dozen member states are expected to breach the bloc’s three per cent deficit ceiling—one more than this year.
A euro crimping competitiveness
Trade dynamics reveal both opportunity and vulnerability. The joint statement on US-EU trade relations issued in August establishes a headline American tariff of 15 per cent on European goods, with exemptions for pharmaceuticals and semiconductors but higher duties on steel and aluminium. Compared with other major economies, Europe enjoys relatively benign treatment: among America’s principal trading partners, only Canada, Mexico, and Britain face lower effective tariff rates. Yet this advantage must be viewed against tepid growth in export markets and a strong euro that crimps competitiveness.
The forecast anticipates that the contribution of net exports to EU growth will be negative in 2025 and 2026 before turning neutral in 2027. Much of this reflects ‘trade diversion’—Chinese manufacturers, facing punitive American tariffs, redirecting excess production to European markets. Evidence already shows Chinese exports to America declining whilst those to Europe surge. Whether this represents dumping or merely commercial pragmatism matters little for the aggregate effect: heightened import competition that restrains domestic inflation but squeezes European producers.
Meanwhile, inflation’s composition tells an intriguing story. Headline rates in the euro zone are projected at 2.1 per cent this year, 1.9 per cent in 2026, and two per cent in 2027. Yet these stable topline figures mask divergent trends beneath. Services and food inflation will weaken gradually as wage growth moderates—from four per cent this year to 3.1 per cent by 2027—and productivity improves. Energy inflation, by contrast, is expected to remain negative through 2026 before turning positive in 2027, should the new EU Emissions Trading System enter force as legislated. Non-energy industrial goods prices will stay subdued, restrained by import competition and euro appreciation.
Optimistic assumptions
The forecast rests on several critical assumptions that may yet prove optimistic. It presumes all tariffs implemented or credibly announced by America’s administration will persist throughout the period. It assumes geopolitical tensions—Russia’s war in Ukraine, instability in the Middle East—will not escalate dramatically. It counts on member states deploying remaining Recovery and Resilience Facility funds by the August 2026 deadline, with other EU programmes filling some of the subsequent gap. And it trusts that persistent trade policy uncertainty will not inflict greater damage than modelled.
Risks tilt decidedly downward. Further fragmentation of global trade could simultaneously dampen growth and rekindle inflation. Increasing climate-related disasters threaten both resilience and output. Volatility in American financial markets—from tech sector repricing to concerns about Federal Reserve independence and fiscal sustainability—could roil investor confidence and tighten financing conditions worldwide. On the upside, resolute progress on the competitiveness agenda, defence spending channelled towards European production, and new trade agreements could provide unexpected lift.
Dombrovskis’s prescription is straightforward: “Given the challenging external context, the EU must unlock domestic growth.” Quite so. Yet translating that imperative into action requires precisely the sort of structural reform and strategic clarity that has long eluded the continent. Europe’s economy continues to grow, certainly. But thriving it is not.
Photo: Dreamstime.
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