Risks and Structural Challenges
While the US-EU trade deal has reduced immediate trade-related uncertainty, the economic outlook is still shaped by fiscal policy debates, geopolitical risks, and structural challenges. The recent trade agreement has eased concerns about a further escalation of tariffs, lowering overall policy uncertainty. However, trade tensions continue to simmer, and the recent escalation in US-China relations following the imposition of export controls on rare earth metals demonstrates that tariff uncertainty has not disappeared. While the risk of additional unprecedented tariffs has diminished, existing measures remain in place and continue to affect the economy.
Germany’s shift to a more expansionary fiscal policy, with higher infrastructure and defense spending, is expected to support euro area growth. Fiscal debates in several countries, including France, and at the EU level remain important, and exceptions for military spending and NATO commitments may further boost government outlays, though high import intensity will limit short-term benefits.
Geopolitical risks persist. The war in Ukraine continues, and Russia has recently conducted several provocations against the EU and NATO countries. While the conflict in Gaza has recently de-escalated, the geopolitical situation in the Middle East remains tense. Any further escalation of these conflicts could increase uncertainty, drive up commodity prices, and disrupt global trade, making Europe particularly vulnerable.
Although manufacturing activity has picked up in recent months, it is unclear whether this trend will be sustained, as tariffs may lead to renewed stagnation or contraction in 2026. Consumption prospects are uncertain, as high savings have yet to translate into stronger spending, while slowing wage growth and weak sentiment weigh on demand. However, growth could rebound if financing conditions improve and inflation falls further.
The recent surge in asset prices, including US equities and precious metals, has reignited concerns about a potential asset bubble. While valuations in European markets remain reasonable and the European economy is less exposed than the US to asset price swings, a potential market correction would negatively affect Europe through weaker sentiment and spillovers from the US.
In Europe, structural competitiveness challenges persist, exacerbated by high energy costs, euro appreciation, and intensified global competition. There is potential for productivity gains through digitalization and AI, and strong immigration could help address demographic pressures, but much will depend on successful labor market integration.
Overall, while near-term risks appear more balanced following the US–EU trade deal, Europe’s medium-term outlook remains challenged by structural competitiveness gaps, policy fragmentation, and lingering global trade tensions.