Deutsche Bank Research has substantially reduced its growth outlook for the euro area in 2026, saying a new energy shock tied to developments in the Middle East will slow activity, raise inflation and undercut investment. The bank cut its full-year GDP forecast to 0.5% from the 1.1% it had projected in its November World Outlook.
In its note, Deutsche Bank outlined a path in which the euro area economy contracts by 0.1% quarter-on-quarter in the second quarter - a reading consistent with current activity trackers - then flattens in the third quarter before returning to modest positive growth in the final quarter of the year. The broker expects growth to rebound to 1.1% in 2027.
The report framed the downgrade as the consequence of an energy-related shock transmitted through four primary channels: a reduction in household purchasing power from higher inflation; heightened uncertainty that depresses investment; tighter monetary policy; and weaker exports as global demand slows. Deutsche Bank estimates the bloc's energy import bill will be about 1% of GDP higher in 2026 as a result.
Headline inflation, measured by the Harmonised Index of Consumer Prices (HICP), is forecast to average 3.1% in 2026 and 2.5% in 2027 - noticeably higher than pre-conflict expectations of 1.7% and 1.9% in those years. Core inflation is projected to be 2.4% in both 2026 and 2027.
Responding to elevated price pressures, Deutsche Bank expects the European Central Bank to raise its deposit rate by a cumulative 50 basis points to 2.50% by September, implemented as quarter-point hikes in June and September. The broker characterises that sequence as "measured tightening."
Germany, the euro area's largest economy, is forecast to expand by 0.5% in 2026 under Deutsche Bank's baseline. The bank expects a slight contraction in output in the second quarter and flat growth in the third quarter, with recovery later in the year. Fiscal stimulus is expected to provide the main stabilising influence on the German economy, with the government deficit widening to 4.1% of GDP. Employment in Germany is forecast to fall by 0.3%.
France and Italy are both projected to record subdued growth next year - France at 0.5% and Italy at 0.4%. For Italy, the 0.4% forecast represents a downgrade from the pre-crisis estimate of 0.8%, leaving it the weakest performer among the euro area's four largest economies. France's budget deficit is projected at 5.2% of GDP in 2026 and 5.4% in 2027.
Deutsche Bank noted that Italy will continue to benefit from funds still available under the European Union's NextGenerationEU recovery programme, with around 72 billion euros - equivalent to 3.5% of GDP - remaining to be deployed at the end of 2025.
Outside the euro area, the United Kingdom is expected to fare relatively better, with growth pegged at 1.0% in 2026. That outlook is supported by a strong 0.6% quarter-on-quarter expansion in the first quarter. Consumer price inflation in Britain is forecast at 3.2%, and Deutsche Bank expects the Bank of England to keep interest rates unchanged at 3.75% through the end of the year.
The report underscored that downside risks remain. In a stress scenario where the Strait of Hormuz stays closed throughout the summer, euro area growth could fall to zero in 2026 while inflation could accelerate to 3.5%.
Deutsche Bank also reflected on the pre-shock macroeconomic picture, saying that before the energy disruption Europe faced a "two-economy problem": short-term cyclical resilience into 2025, partly supported by German fiscal spending in 2026, contrasted with a medium-term outlook clouded by weak competitiveness and insufficient strategic autonomy.
Implications for markets and sectors
- Higher energy costs and an increased import bill will weigh on household real incomes and consumer-facing sectors that depend on discretionary spending.
- Tighter monetary policy and weaker investment visibility could depress capital spending and affect sectors sensitive to financing costs.
- Export-dependent industries face pressure from softer global demand, with implications for manufacturing and trade-exposed firms.
While the baseline outlook still includes a return to growth in late 2026 and a pickup in 2027, the note makes clear that outcomes are highly contingent on developments in energy markets and broader demand conditions. The combination of higher inflation, narrower purchasing power and constrained investment underwrites the bank's more cautious near-term growth profile for the euro area.