The EU’s Spring Economic Forecast shows a slowdown in growth as the energy shock drives up inflation and puts new strain on finances.
It has not, to say the least, been the most promising of weeks for Europe’s economy. On May 21, the European Commission released its Spring Economic Forecast which, somewhat predictably, shows a slowdown in growth as the energy shock caused by the US war on Iran drives up inflation.
Before the war began at the end of February, the European Union’s economy was set to keep expanding (albeit at a moderate pace) alongside a further decline in inflation. The outlook, however, has changed substantially since the outbreak of the conflict. Inflation started picking up quickly, driven by the sharp increase in energy commodity prices, and economic activity is losing momentum. The situation is set to improve slightly in 2027, but only if tensions on energy markets ease.
After reaching 1.5 per cent in 2025, GDP growth in the EU is now projected to slow down to 1.1 per cent in 2026, a downward revision of 0.3 percentage points from the Autumn 2025 Economic Forecast projection (1.4 per cent). GDP growth is then set to edge up to 1.4 per cent in 2027. Growth projections for the euro area are similarly revised down, to 0.9 per cent in 2026 and 1.2 per cent in 2027, from 1.2 per cent and 1.4 per cent respectively. Of the EU’s major economies, Poland is set for the highest growth this year, at 3.5 per cent, although even that is down from 3.6 per cent in 2025. At the other end of the scale, there will be concerns about Romania, currently without a permanent government, where the economy will stagnate (growing, if we can call it that, by just 0.1 per cent this year).
Inflation in the EU is expected to reach 3.1 per cent in 2026, a full percentage point higher than previously forecast, easing again to 2.4 per cent in 2027. In the euro area, inflation is also revised up to three per cent in 2026 and to 2.3 per cent in 2027, compared to the autumn projections of 1.9 per cent and two per cent respectively.
As a net energy importer, the EU’s economy is highly susceptible to the energy shock caused by the conflict in the Middle East, the second such shock in less than five years (the previous shock being Russia’s ongoing invasion of Ukraine). The spike in energy prices means higher household bills and surging business costs that reduce profits for many industries, effectively redirecting income out of the EU economy and into energy-exporting countries.
Since the US began its war on Iran, consumer confidence in the EU has fallen to a 40-month low, amid mounting fears of surging inflation and job losses. Nevertheless, consumption is expected to remain the main driver of growth. Business investment is also set to be constrained by tighter financing conditions, lower profits and heightened uncertainty. Weaker external demand is also weighing on export growth.
The EU remains insistent, however, that its investment in energy resilience, especially in the aftermath of Russia’s invasion of Ukraine, is paying off. The push towards supply diversification, decarbonisation, and lower energy consumption has left the EU economy better placed to absorb today’s shock, it says.
Inflation, employment, public finances
The short-term inflation outlook has deteriorated since the Autumn 2025 Forecast, with data from March and April already showing a sharp acceleration driven by energy prices. Headline inflation is now set to peak in 2026 before easing in 2027, as energy commodity prices are expected to gradually decline, albeit remaining around 20 per cent above pre-war levels.
Employment is also under strain. In 2025, employment grew by 0.5 per cent, adding more than one million jobs to the EU economy. In 2026, employment growth is forecast to slow down to 0.3 per cent, edging up again to 0.4 per cent in 2027. The long-term decline in the unemployment rate is set to come to an end, stabilising at around six per cent in 2027. Nominal wage growth is set to remain strong, as wages adjust to higher inflation.
General government deficit in the EU is expected to increase from 3.1 per cent of GDP in 2025 to 3.6 per cent by 2027, reflecting subdued economic activity, higher interest expenditure, measures to cushion the impact of higher energy prices on vulnerable households and firms, and increased defence spending. Public investment in the EU is set to stabilise at high levels in 2027, despite the end of Recovery and Resilience Facility disbursements.
The EU debt-to-GDP ratio is also projected to rise from 82.8 per cent in 2025 to 84.2 per cent in 2026 and 85.3 per cent in 2027.In the euro area the ratio is set to rise from 88.7 per cent in 2025 to 90.2 per cent and 91.2 per cent in 2026 and 2027 respectively. This reflects higher primary deficits and an increasingly unfavourable interest-growth differential.
Continued supply tensions weigh on the outlook
The major risk surrounding the forecast concerns the duration of the conflict in the Middle East and its implications for global energy markets. Given the unusually high degree of uncertainty, and the narrowing window for a rapid normalisation of supply conditions, the baseline forecast is complemented by an alternative scenario assuming more prolonged disruptions. Under this scenario, energy commodity prices are assumed to rise significantly above baseline futures curves, peaking in late 2026 before gradually realigning with them by the end of 2027. Under this scenario, inflation would not ease and economic activity would fail to rebound in 2027 as projected in the baseline forecast. In addition, higher prices could prompt households and firms to scale back consumption and investment more sharply.
Moreover, outright supply shortages for specific commodities and inputs, for example some refined oil products, helium and fertilisers, could intensify with knock-on effects for global production chains and food affordability. The ongoing softening of labour demand (as evidenced by declining job vacancies and hiring rates) could signal a more adverse impact on employment growth ahead. Continued uncertainty surrounding global trade policies and the ongoing reconfiguration of geopolitical and trade relationships could further weigh on confidence and activity.
Faster implementation of structural reforms addressing long-standing bottlenecks to EU growth remains an important upside risk to the outlook. Strong public investment in sectors such as defence and the energy transition may offset some of the weakness expected in the private sector. Artificial intelligence represents both opportunity and risk: productivity gains could support investment in the EU, while labour market disruption could weigh on demand.
Photo: Dreamstime.