Economic, financial and monetary developments

Overview

At its meeting on 19 March 2026, the Governing Council decided to keep the three key ECB interest rates unchanged. It is determined to ensure that inflation stabilises at the 2% target in the medium term. The war in the Middle East has made the outlook significantly more uncertain, creating upside risks for inflation and downside risks for economic growth. It will have a material impact on near-term inflation through higher energy prices. Its medium-term implications will depend both on the intensity and duration of the conflict and on how energy prices affect consumer prices and the economy.

The Governing Council is well positioned to navigate this uncertainty. Inflation has been at around the 2% target, longer-term inflation expectations are well anchored and the economy has shown resilience over recent quarters. The incoming information in the period ahead will help the Governing Council assess how the war will affect the inflation outlook and the risks surrounding it. The Governing Council is closely monitoring the situation and its data-dependent approach will help it set monetary policy as appropriate.

The March 2026 ECB staff macroeconomic projections for the euro area exceptionally incorporate information up to 11 March, a later cut-off date than usual. In the baseline, headline inflation is seen to average 2.6% in 2026, 2.0% in 2027 and 2.1% in 2028. Inflation has been revised up compared with the December 2025 Eurosystem staff macroeconomic projections for the euro area, especially for 2026. This is because energy prices will be higher owing to the war in the Middle East. For inflation excluding energy and food, staff project an average of 2.3% in 2026, 2.2% in 2027 and 2.1% in 2028. This is also higher than the path in the December 2025 projections, mainly owing to higher energy prices feeding into inflation excluding energy and food. Staff expect economic growth to average 0.9% in 2026, 1.3% in 2027 and 1.4% in 2028. This implies a downward revision, especially for 2026, reflecting the global effects of the war on commodity markets, real incomes and confidence. At the same time, low unemployment, solid private sector balance sheets and public spending on defence and infrastructure should continue to underpin growth.

In line with the Governing Council’s monetary policy strategy commitment to incorporate risks and uncertainty into its decision-making, staff also assessed how the war in the Middle East could affect economic growth and inflation under some alternative illustrative scenarios. These scenarios are included in the March 2026 projections, which are available on the ECB’s website. The scenario analysis suggests that a prolonged disruption in the supply of oil and gas would result in inflation being above, and growth being below, the baseline projections. The implications for medium-term inflation depend crucially on the magnitude of indirect and second-round effects of a stronger and more persistent energy shock.

The Governing Council will follow a data-dependent and meeting-by-meeting approach to determining the appropriate monetary policy stance. In particular, its interest rate decisions will be based on its assessment of the inflation outlook and the risks surrounding it, in light of the incoming economic and financial data, as well as the dynamics of underlying inflation and the strength of monetary policy transmission. The Governing Council is not pre-committing to a particular rate path.

Economic activity

The economy grew by 0.2% in the fourth quarter of 2025, driven by stronger domestic demand. Households increased their spending as real incomes rose and unemployment remained close to its historical low. Construction and housing renovation strengthened and firms invested more, particularly in areas such as research and development, software, and databases. Growth was no longer weighed down by net exports as it had been in the previous two quarters. It was underpinned mainly by services.

Staff still see private consumption as the main driver of growth over the medium term. Investment should also continue to grow, with governments spending more on defence and infrastructure, and firms increasingly investing in new digital technologies. The external environment remains challenging, including in light of volatile global trade policies.

The war in the Middle East is disrupting commodity markets and weighing on real incomes and confidence. This has led to a downward revision of consumption and investment in the baseline staff projections, especially for 2026. The baseline projections foresee annual real GDP growth of 0.9% in 2026, 1.3% in 2027 and 1.4% in 2028. Compared with the December 2025 projections, GDP growth has been revised down by 0.3 percentage points for 2026 and by 0.1 percentage points for 2027, on account of the escalating war in the Middle East, while for 2028 it is unchanged. The impact would be even more pronounced in alternative scenarios with a more severe and prolonged energy shock.

The baseline staff projections are conditioned on the paths of futures prices for energy commodities at the time of the cut-off date of 11 March 2026. Accordingly, the baseline foresees a pick-up in inflation, which will dampen purchasing power, consumer spending and, hence, GDP growth, especially in the short term. Conditional on a relatively rapid reduction in energy prices, as is priced in by the energy commodity futures markets, and in uncertainty, this slowdown is expected to be temporary. Over the medium term, domestic demand should remain the main driver of euro area growth, bolstered by a resilient labour market and government spending on infrastructure and defence, especially in Germany. On the external side, while export growth is expected to pick up on the back of improving foreign demand, the euro area will likely experience a continued loss of global market shares, given persistent competitiveness challenges, including some that are of a structural nature. This is notwithstanding the fact that tariffs on exports to the United States are somewhat lower than at the time of the December 2025 projections.

The Governing Council highlighted the urgent need to strengthen the euro area economy while maintaining sound public finances. Any fiscal responses to the energy price shock should be temporary, targeted and tailored. The current energy crisis underscores the imperative to further reduce dependence on fossil fuels. Completing the savings and investments union is vital to fund innovation and support the green and digital transitions. The digital euro and tokenised wholesale central bank money will enhance Europe’s strategic autonomy, competitiveness and financial integration, and will boost innovation in payments. It is thus essential to swiftly adopt the Regulation on the establishment of the digital euro. Simplifying and harmonising rules across the EU’s Single Market will help European firms grow faster.

Inflation

Euro area annual inflation, as measured by the Harmonised Index of Consumer Prices (HICP), rose to 1.9% in February, from 1.7% in January. Energy prices were 3.1% lower than in the previous February, after being 4.0% lower in January 2026. Food price inflation edged down to 2.5%. By contrast, inflation excluding energy and food increased to 2.4% in February, from 2.2% in January. The increase reflected goods inflation rising to 0.7% from 0.4% and services inflation moving up to 3.4% from 3.2%.

Indicators of underlying inflation have changed little over recent months and remain consistent with the Governing Council’s 2% medium-term target. Corporate profits recovered further in the fourth quarter of 2025, while unit labour costs rose at a similar rate as in the previous quarter. Growth in compensation per employee slowed to 3.7%, from 4.0% in the third quarter. Negotiated wage growth and forward-looking indicators, such as the ECB’s wage tracker and the results of surveys on wage expectations, suggest that labour costs will ease further in the course of 2026, which should support the return of inflation to target.

The increase in energy prices caused by the war in the Middle East will drive inflation above 2% in the near term. In particular, inflation is projected to increase sharply to 3.1% in the second quarter of 2026, driven by a surge in energy inflation as a result of the war, and then to decline in the third quarter to 2.8% following declines in energy commodity prices as embedded in futures prices. The baseline projections foresee energy inflation turning negative in 2027, mainly owing to downward energy base effects, and then increasing notably in 2028 when the implementation of the EU Emissions Trading System 2 (ETS2) is expected to have an upward impact of 0.2 percentage points on headline inflation. Food inflation is projected to pick up from the end of 2026, as cost pressures from the spike in energy prices feed through to consumer food prices, before easing in 2028. HICP inflation excluding energy and food (HICPX) is projected to moderate from 2.4% in 2025 to stand at 2.1% in 2028. While HICPX inflation is also affected by cost pressures stemming from higher energy prices, this is seen to be tempered by some easing in labour cost pressures, the past appreciation of the euro and import penetration from China. Overall, the baseline projections foresee HICP inflation picking up from 2.1% in 2025 to 2.6% in 2026, before declining to 2.0% in 2027 and then ticking up to 2.1% in 2028. Wage growth will moderate over the coming years, albeit at a slower pace than foreseen in previous projections on account of some inflation compensation effects related to the energy price shock. Compared with the December 2025 projections, the outlook for headline HICP inflation has been revised up by 0.7 percentage points for 2026, mainly owing to the energy component. It has been revised up by 0.2 percentage points for 2027 and by 0.1 percentage points for 2028 as cost pressures stemming from higher energy prices feed through to the HICPX and food components, while the energy component has been revised down somewhat. The upward revisions to inflation would be even more pronounced in alternative scenarios with a more severe and prolonged energy shock.

If more persistent, higher energy prices may lead to a broader increase in inflation through indirect and second-round effects, a situation which requires close monitoring. So far, while inflation expectations in the financial markets have moved up significantly over shorter horizons, most measures of longer-term inflation expectations stand at around 2%, supporting the stabilisation of inflation around the Governing Council’s target.

Risk assessment

The risks to the growth outlook are tilted to the downside, especially in the near term. The war in the Middle East is a downside risk to the euro area economy, adding to the volatile global policy environment. A prolonged war could increase energy prices further and for longer than currently expected, and also weigh on confidence. These factors would erode incomes and make firms and households more reluctant to invest and spend. A worsening of global financial market sentiment could further dampen demand. Additional frictions in international trade could disrupt supply chains, reduce exports and weaken consumption and investment. Other geopolitical tensions, in particular Russia’s unjustified war against Ukraine, remain a major source of uncertainty. By contrast, growth could turn out to be higher if the economic repercussions of the war in the Middle East proved to be more short-lived than currently expected. Moreover, planned defence and infrastructure spending, reforms to enhance productivity and euro area firms adopting new technologies may drive up growth by more than expected. New trade agreements and a deeper integration of the Single Market could also boost growth beyond current expectations.

The risks to the inflation outlook are tilted to the upside, especially in the near term. A prolonged war in the Middle East could lead to a larger and longer-lasting upward shift in energy prices than currently expected, raising euro area inflation further. This could be reinforced and become more persistent if inflation expectations and wage growth were to rise in response, if the energy price increase were to spill over to non-energy inflation to a larger extent than assumed in the baseline, or if the war disrupted global supply chains more broadly. Ongoing trade tensions could also give rise to more fragmented global supply chains, curtail the supply of critical raw materials and tighten capacity constraints in the euro area economy. By contrast, inflation could turn out to be lower if the economic repercussions of the war in the Middle East proved to be more short-lived or if indirect and second-round effects proved less pronounced than currently expected. Inflation could also be lower if tariffs reduced demand for euro area exports by more than expected and if countries with overcapacity increased further their exports to the euro area. More volatile and risk-averse financial markets could weigh on demand and thereby lower inflation as well.

Financial and monetary conditions

The war in the Middle East has had a pronounced impact on global financial markets. Overall financial conditions have tightened since the Governing Council’s last monetary policy meeting on 5 February 2026. Stock markets have fallen and market interest rates in the euro area, especially short-term rates, have risen notably.

In January bank lending rates for firms and the cost of issuing market-based debt both remained at 3.6%, while the average interest rate on new mortgages edged up to 3.4%. Bank lending to firms grew by 2.8% on a yearly basis in January, down from 3.0% in December 2025. However, this was offset by stronger issuance of corporate bonds, with the annual growth rate rising to 4.0%, from 3.5% in December. Mortgage lending grew by 3.0%, unchanged from December.

Monetary policy decisions

The interest rates on the deposit facility, the main refinancing operations and the marginal lending facility were kept unchanged at 2.00%, 2.15% and 2.40% respectively.

The asset purchase programme and pandemic emergency purchase programme portfolios are declining at a measured and predictable pace, as the Eurosystem no longer reinvests the principal payments from maturing securities.

Conclusion

At its meeting on 19 March 2026, the Governing Council decided to keep the three key ECB interest rates unchanged. It is determined to ensure that inflation stabilises at its 2% target in the medium term. It will follow a data-dependent and meeting-by-meeting approach to determining the appropriate monetary policy stance. The Governing Council’s interest rate decisions will be based on its assessment of the inflation outlook and the risks surrounding it, in light of the incoming economic and financial data, as well as the dynamics of underlying inflation and the strength of monetary policy transmission. The Governing Council is not pre-committing to a particular rate path.

In any case, the Governing Council stands ready to adjust all of its instruments within its mandate to ensure that inflation stabilises sustainably at its medium-term target and to preserve the smooth functioning of monetary policy transmission.

1 External environment

Adverse effects on the global economy from the war in the Middle East primarily result from the sharp increase in energy prices. Together with tighter financial conditions and heightened uncertainty, this has had a negative impact on the global economy, which had previously been bolstered by rising investment related to artificial intelligence (AI) and supportive economic policies. While lower US tariffs following a US Supreme Court ruling have provided some support to growth, trade policy uncertainty remains elevated. It is estimated that the war will reduce global real GDP growth by 0.4 percentage points over the next two years, reflecting the expected trajectory of energy commodity prices. This has offset the positive carry-over effects stemming from stronger than expected growth in late 2025 and the moderate boost from lower US tariffs. Global headline consumer price index (CPI) inflation has been revised upwards over the next two years, driven by the energy price shock. In the first few months of this year, the inflationary impact of higher energy prices was partially offset by lower than expected inflation data and the effects of reduced tariffs.

Before the war, the global economy showed signs of resilience. This resilience was driven by rising private investment related to AI and a supportive policy mix across major economies, both of which had helped to buffer tariff-related headwinds. While lower US tariffs following a US Supreme Court ruling have provided some support to growth, trade policy uncertainty remains elevated. Global real GDP growth (excluding the euro area) declined slightly to 0.8% in the fourth quarter of 2025, down from 1.0% in the previous quarter. This was higher than expected owing to the stronger than previously expected growth in Asian emerging economies, including in China. The latest available monthly indicators point to a rise in growth momentum in the first quarter of 2026 compared with the end of last year. For example, in February the global composite output Purchasing Managers’ Index (PMI) reached levels unseen in almost two years as output from both services and manufacturing sectors improved (Chart 1). However, these signals should be viewed in the context of adverse effects triggered by the war, including the sharp increase in global energy commodity prices, tighter global financial conditions and heightened uncertainty.

Chart 1

Global output PMI (excluding the euro area)

(diffusion indices)

Oil and gas prices have risen markedly against the backdrop of the war in the Middle East. Oil prices have risen sharply, by 84% since the beginning of the review period (18 December 2025). Following the US and Israeli strikes on Iran and Iran’s subsequent retaliation, oil prices increased to around USD 104 per barrel. This surge reflected concerns that shipments through the Strait of Hormuz, which account for around 20% of the global oil supply and which were already being disrupted, could be further impeded or that Iran’s oil production and regional energy infrastructure could be affected. In recent weeks, oil prices have been subject to significant volatility, as several factors have intermittently triggered abrupt falls from recent highs. In particular, statements by the US Administration suggesting that the conflict could end “very soon” led investors to revise their expectations downwards with regard to the duration of the war. In addition, OPEC+ announced an output increase as of April 2026, and member countries of the Organisation for Economic Co-operation and Development (OECD) agreed, under the coordination of the International Energy Agency, to release part of their strategic reserves to help contain the oil price surge.^[1] Geopolitical risks have also sharply affected European gas prices, which have risen by 98%, as approximately 20% of global liquefied natural gas supplies, primarily from Qatar, also transit through the Strait of Hormuz. Gas prices have been particularly vulnerable on account of historically low European storage levels. Inventories currently stand at around 29% of capacity, close to the seasonal minimum, making gas prices particularly exposed to potential supply disruptions. Food prices have declined by 7%, driven mainly by lower cocoa prices reflecting improved weather conditions in West Africa. By contrast, metal prices have increased by 11%, largely owing to a rise in aluminium prices after a major Bahraini producer announced that it could not meet its contractual obligations due to circumstances beyond its control.

The sharp increase in global energy commodity prices triggered by the war reflects a sharp drop in shipments through the Strait of Hormuz. Early evidence from high-frequency data tracking vessel movements suggests that the number of tankers transiting through the Strait of Hormuz has fallen sharply and global shipping costs for transporting oil have risen significantly (Chart 2). However, the exposure of global merchandise trade appears limited, as container vessels currently in the Persian Gulf only account for around 1.6% of global containership capacity. Much of the traffic continues to be rerouted through the Cape of Good Hope following disruptions in the Suez Canal related to previous regional tensions and intensified security risks in the Bab el-Mandeb Strait since late 2023 related to Houthi rebel attacks on cargo ships.

Chart 2

Global shipping traffic and prices

a) Vessel transit calls at major maritime chokepoints

(indices, 2025 = 100)

b) Maritime transportation costs

(indices, 2025 = 100)

It is estimated that the war in the Middle East will reduce global real GDP growth by 0.4 percentage points over the next two years. This reflects the negative growth effects resulting from the expected trajectory of energy commodity prices.^[2] It offsets the positive carry-over effects stemming from stronger than expected growth in late 2025 and the moderate boost from lower US tariffs. Global real GDP growth is projected to decline from 3.6% in 2025 to 3.3% in 2026 and remain stable thereafter, broadly unchanged from the previous projections.^[3]

Uncertainties surrounding the war have shifted the balance of risks for global growth to the downside, with tilting inflation risks to the upside. The risks associated with the war in the Middle East appear largely asymmetric, with increased severe impacts considered more likely than milder impacts. By contrast, other key macroeconomic and financial risks such as tariffs, AI-related developments and the effects of economic policies remain two-sided and balanced, as in previous projections.

Before the war, headline inflation across OECD member countries continued to drift lower, mainly driven by lower energy prices. The annual rate of CPI inflation across OECD member countries excluding Türkiye declined to 2.1% in January, down from 2.4% in December. While all components contributed to the lower inflation outcome, the contribution from falling energy prices was the most significant (Chart 3).

Chart 3

OECD CPI inflation

(year-on-year percentage changes, percentage point contributions)

The downward trend in inflation across OECD member countries is expected to be reversed soon owing to the energy price shock resulting from the war. Projected global headline CPI inflation has been revised upwards over the next two years, driven by the energy price shock.^[4] This year the inflationary impact of higher energy prices has so far been partially offset by lower than expected inflation data and the effects of reduced tariffs. Global headline inflation is projected to remain at 3.1% in 2026, unchanged from last year, before decreasing to 2.7% in 2027 and 2.5% in 2028.

Global import growth is projected to decline in 2026 as the effects of frontloaded imports dissipate and the adverse impacts of tariffs and the war take hold. Quarterly growth rates of global imports fell sharply in the second half of 2025, although third quarter data were slightly stronger than previously estimated. Global import growth is projected to gradually normalise throughout 2026 and remain steady thereafter. Over the 2027-28 period, global imports are expected to grow in line with global economic activity. Global imports increased by 5.0% in 2025, substantially stronger than expected in December 2025 (up by 0.6 percentage points). Their growth rate is projected to slow to 2.3% in 2026, before recovering to 2.9% in 2027 and 3.2% in 2028.

In the United States, real GDP growth declined in the fourth quarter of 2025, mainly on account of the US Government shutdown. Economic activity slowed significantly to 0.2% on a quarterly basis, down from 1.1% in the third quarter of 2025. The US Government shutdown in October and November, lasting 43 days, dampened economic activity as government spending declined markedly. However, fourth quarter consumer spending remained relatively strong and was a key driver of domestic demand, notwithstanding a slight slowdown compared with the third quarter. The savings rate in the United States fell further to 3.6% in the fourth quarter, which is the lowest rate over the past four years. Meanwhile, private non-residential fixed investment contributed positively to growth, bolstered by the ongoing AI-related investment boom. In contrast to earlier in 2025, contributions from net trade and inventories were very small. Both imports and exports declined modestly in the final quarter of 2025, leaving the contribution from net exports broadly neutral. Growth is expected to have increased in the first quarter of 2026, largely owing to stronger government spending related to the back pay for federal workers following the government shutdown.

Annual headline and core CPI inflation in the United States remained unchanged in February at 2.4% and 2.5% respectively, in line with expectations. Inflation in goods and services components also remained stable, though a decline in the prices of used cars and trucks masked the increase in prices of the remaining goods components. This indicates an ongoing pass-through of US tariffs to consumer prices in the United States. Headline personal consumption expenditures (PCE) inflation, the Federal Reserve System’s preferred inflation measure, has shown a slight upward trend since the beginning of last year. In December headline annual PCE inflation stood at 2.9% and the core measure at 3.0%. The lower weight of housing components in the PCE basket relative to the CPI basket explains the divergence between the two measures of consumer inflation. However, it is unusual for PCE inflation to exceed CPI inflation. This suggests that issues surrounding the data collection for services, prices and rents could explain the relatively subdued readings of CPI inflation, which should therefore be interpreted with caution. Meanwhile, falling vacancy rates across sectors have further eased conditions in the labour market and should therefore support disinflation.

In China household demand remains subdued amid high precautionary savings. Real GDP growth surprised on the upside at 1.2% in the fourth quarter of 2025 and remained broadly comparable with the 1.1% growth recorded in the previous quarter. It was driven mainly by resilient exports, which are also expected to have continued supporting growth in the first quarter of 2026. High-frequency proxies for consumption point towards some softening as consumer confidence remains low and well below pre-COVID 19 pandemic levels. Retail sales remain weak, particularly for domestic car sales, although services consumption has been more resilient. However, the Chinese authorities continue to prioritise supply-side policies and the growth target for 2026 under their new five-year plan (2026-30) is in the range of 4.5-5%. This relatively low growth target suggests that Chinese policymakers are accepting structurally slower growth, which in turn reduces the need for a short-term stimulus. The Chinese authorities reiterated their intention to rebalance growth towards consumption, albeit concrete measures remain modest. Meanwhile, fiscal support for investment is set to remain substantial, particularly in high-tech and strategic sectors such as AI, microchips, advanced manufacturing, biotechnology and the digital economy. At the same time, however, China remains exposed to rising energy commodity prices. It imports around three-quarters of its crude oil consumption, and around half of its oil and 16% of its gas imports transit the Strait of Hormuz. Nonetheless, extensive domestic coal production, rising renewables energy production capacity, as well as the ability to diversify its energy commodity suppliers may dampen this negative effect. Headline CPI inflation in China increased markedly in February, and deflation in producer prices continued to ease. Annual headline CPI inflation rose to 1.3% in February, up from 0.2% in the previous month, driven by temporary factors, including the base effects related to the timing of the Lunar New Year. Core inflation (excluding food and energy) also climbed to 1.8% in February, up from 0.8% in January, largely owing to rising tourism-related service prices. Producer prices declined in February by 0.9% in annual terms, which was a smaller decline compared with the 1.4% drop recorded in the previous month.

In the United Kingdom, real GDP growth remained weak in the fourth quarter of 2025, whereas inflation eased significantly in early 2026. Real GDP growth edged up by 0.1% in the fourth quarter of 2025, a steady – albeit subdued – growth momentum. Private demand was weak, amid softer growth in private consumption and lower private investment. Net exports contributed negatively to economic activity, as exports declined and imports increased. Public spending provided some support, with a notable rise in public investment. Economic activity is expected to have picked up moderately in the first quarter of 2026, although the sharp increase in energy prices is expected to weaken this momentum in subsequent quarters. Headline CPI inflation eased significantly to 3.0% in January, down from 3.4% in December, mostly reflecting lower energy and food inflation. Core inflation also declined, albeit more moderately.

2 Economic activity

Euro area economic activity demonstrated steady growth during 2025, with real GDP expanding by an average of 1.5%, up from 0.9% in 2024. In the fourth quarter of 2025 real GDP increased by 0.2%, quarter on quarter, and 0.4% when excluding volatile Irish data. Growth was driven by stronger domestic demand, including solid contributions from both private consumption and investment. However, short-term indicators softened at the end of 2025 and into early 2026. Monthly production weakened significantly, in contrast to survey results, which remained positive and pointed to continued momentum before the war in the Middle East. Taken together, the latest information is consistent with modest GDP growth in the first quarter of 2026. The evolving situation in the Middle East has markedly increased uncertainty surrounding the outlook from the second quarter onwards. Market-based indicators of uncertainty and geopolitical risk measures rose sharply in the first half of March. Experience from past adverse energy-related shocks suggests that the resulting erosion of real income and deterioration in confidence could weigh significantly on private consumption. The strength of these effects will depend both on the intensity and duration of the conflict and its pass-through to the economy. On the positive side, healthy balance sheets and elevated savings should help cushion the impact of the shock on households. For other components of demand, survey data collected before the conflict indicated strengthening housing demand and rising investor confidence. Moreover, additional fiscal support, effects from the Next Generation EU (NGEU) programme, resilient labour markets and digital investment, as well as the impact of previous interest rate cuts, should help maintain investment momentum in the coming quarters. Labour market conditions remain stable despite a continued moderation in labour demand. The unemployment rate declined to 6.1% in January, from 6.2% in December, remaining at historically low levels.

This outlook is broadly reflected in the March 2026 ECB staff macroeconomic projections for the euro area, which foresee annual average real GDP growth of 0.9% in 2026, 1.3% in 2027 and 1.4% in 2028. This implies a downward revision, especially for 2026, reflecting the global effects of the war on commodity markets, real incomes and confidence. At the same time, low unemployment, solid private sector balance sheets, and public spending on defence and infrastructure should continue to underpin growth. The war in the Middle East has made the outlook significantly more uncertain, creating upside risks for inflation and downside risks for economic growth. Given the very high levels of uncertainty and that the impact of the conflict will depend strongly on its duration and intensity, the baseline is accompanied by some illustrative alternative scenarios published with the staff projections on the ECB’s website.^[5]

Euro area GDP continued to rise in the fourth quarter of 2025, according to the latest estimate from Eurostat (Chart 4). Real GDP increased by 0.2%, quarter on quarter, leading to an average annual growth rate of 1.5% in 2025 (working day adjusted). This improvement compared with 2024, together with the fact that GDP growth was positive in all quarters of last year, underscores the resilience of the euro area economy amid a number of global challenges related to geopolitics and trade. GDP growth was driven by stronger domestic demand in the fourth quarter of 2025, with all domestic demand components contributing positively, while net trade and changes in inventories each made a small negative contribution. The increase in output was mainly driven by services, notably in the information and communication sector. Meanwhile, manufacturing remained weak, as it was directly affected by headwinds stemming from higher tariffs and geopolitical uncertainty (see Box 4 on the impact of trade policy uncertainty on euro area growth). Momentum in the construction and housing renovation sector strengthened, also supported by public investment. Notwithstanding the notable differences across countries, dispersion in euro area real GDP growth was less heterogenous in the fourth quarter of 2025 compared with earlier quarters. The fourth quarter outcome for the euro area generated a carry-over effect of 0.3% for annual growth in 2026.

Chart 4

Euro area real GDP and its components

(quarter-on-quarter percentage changes; percentage point contributions)

Short-term indicators softened towards the end of 2025 and into early 2026. Industrial production (excluding construction) declined both in December 2025 and January 2026, by 0.6% and 1.5%, month on month, respectively. As a result, the level of industrial production in January 2026 stood 1.9% below its average level for the fourth quarter of 2025. By contrast, survey indicators remained more positive in the first two months of 2026. The euro area composite output Purchasing Managers’ Index (PMI) signalled steady improvements in manufacturing activity in January and February, both for current output and new orders, while new export orders remained in contractionary territory (Chart 5, panel a). The services PMI softened in the first two months of the year from the high level reached at the end of 2025, yet it remained above the threshold of 50 (Chart 5, panel b). Taken together, the latest information is consistent with modest GDP growth in the first quarter of 2026.

Chart 5

PMI indicators across sectors of the economy

a) Manufacturing	b) Services
(diffusion indices)	(diffusion indices)

Labour market conditions remain stable overall, despite the continued moderation in labour demand. Employment and total hours worked increased by 0.2% and 0.6% respectively in the fourth quarter of 2025 (Chart 6). The ongoing moderation in employment growth partly reflects a continued softening in labour demand, with the job vacancy rate stabilising at 2.2% in the fourth quarter, remaining below the pre-pandemic levels observed in the fourth quarter of 2019 for the second consecutive quarter. The labour force expanded further in the fourth quarter of 2025, while January numbers indicate a month-on-month stabilisation. At the same time, the unemployment rate stood at 6.1% in January, down from 6.2% in December, remaining at historically low levels.

Chart 6

Euro area employment, PMI assessment of employment and unemployment rate

(left-hand scale: quarter-on-quarter percentage changes, diffusion index; right-hand scale: percentages of the labour force)

Short-term labour market indicators suggest muted employment growth in the first quarter of 2026. The monthly composite PMI employment index stood at 49.9 in both January and December, suggesting broadly flat employment growth in the first quarter of the year. The PMI for employment in the services sector decreased to 50.3, from 51.3 at the end of 2025, while the PMI for employment in manufacturing recovered but remained in negative territory, reaching 48.9 in the February release, with an average of 48.5 in the first two months of the year.

Private consumption strengthened in the fourth quarter of 2025, as real incomes rose and unemployment remained close to its historical low. Private consumption expanded by 0.5% quarter on quarter, in the fourth quarter of last year, following more modest growth of 0.2% in the previous quarter (Chart 7, panel a). Spending on both services and goods contributed to this expansion. Before the outbreak of the war in the Middle East, survey indicators pointed to sustained consumption momentum in the short term, but the conflict now poses downside risks to the outlook. Survey evidence suggests that the positive momentum in private consumption continued into the early months of 2026, with the European Commission’s consumer confidence indicator improving further in February. Across contact-intensive services, the Commission’s indicators of expected demand weakened for food and beverage services, while strengthening for travel services and, to a lesser extent, for accommodation services. Consistent with this, the Consumer Expectations Survey indicated that expectations for holiday-related purchases remained strong. Looking ahead the outlook for private consumption is subject to significant headwinds, stemming from the impact of the war in the Middle East. Increased geopolitical uncertainty could weigh on consumer confidence, as observed around past geopolitical conflicts (Chart 7, panel b). In addition, higher energy prices may also dampen real income growth and restrain household spending. At the same time, several factors should continue to support momentum in private consumption. Real income gains accumulated in recent years, together with the fact that the real wealth losses incurred during the inflation surge in 2022 have now been recouped, should help cushion households from the impact of the energy shock and support private consumption, which is seen as the main driver of growth over the medium term.

Chart 7

Household consumption, business and consumer expectations, and consumer confidence around geopolitical conflicts

a) Household consumption and confidence, business expectations	b) Consumer confidence around geopolitical conflicts
(quarter-on-quarter percentage changes, standardised percentage balances)	(net percentage balances)

Business investment grew further at the end of 2025 and the underlying momentum remained positive, albeit likely dampened by the conflict in the Middle East. Non-construction investment (excluding volatile intangibles in Ireland) grew by 0.4%, quarter on quarter, in the fourth quarter of 2025, resulting in annual growth of 2.2% for the year as a whole (Chart 8, panel a). Fourth quarter growth was driven by both intangibles (excluding the Irish intellectual property products component) and tangibles, with the latter supported by an increase in machinery and equipment. Moving into 2026, ahead of the conflict in the Middle East, a range of indicators pointed to continuing investment growth. Preliminary earnings calls data up to the end of February suggested improving sentiment regarding both investment and profits in the first quarter. Similarly, at the start of the year, PMI output and activity measures rebounded sharply from the lulls seen at the end of 2025. The European Commission confidence indicator has also slowly recovered – particularly within the (tangible) capital goods sector – amid expectations of rising demand and additional fiscal support in some countries. Confidence remained strong among suppliers of intangible assets, supported by rapid advances in AI that continue to spur digital investment (see also Box 5 and Box 6). Looking forward, renewed uncertainty will likely weigh on investment as long as the conflict in the Middle East persists.^[6] However, improved financing conditions, further crowding-in effects expected from the NGEU programme, the ongoing build-up of defence capacity in many countries, as well as the continuing digitalisation and AI-driven investment cycle, should support solid investment growth ahead.

Housing investment increased significantly in the fourth quarter of 2025 and is expected to continue expanding in the near term. Housing investment rose by 2.3%, quarter on quarter, in the fourth quarter of 2025 (Chart 8, panel b). Growth in housing investment was broad-based across euro area countries, but was particularly strong in Italy, where the latest data also point to stronger housing investment growth in previous quarters. This has led to housing investment growth for the euro area as a whole being revised upwards, indicating that the recent recovery appears to be stronger than previously estimated. Meanwhile, production in building construction and specialised construction activities was, on average, 0.3% higher in the fourth quarter than in the preceding quarter. Looking ahead, both the European Commission’s indicator of recent trends in building and specialised construction activity and the PMI housing output index strengthened in February, following a drop in January. While residential building permits declined somewhat in October and November compared with the third quarter of 2025, the less volatile three-month-on-three-month measure remained positive, consistent with a further recovery in housing investment in the near term. This assessment is reinforced by the improving consumer sentiment towards housing. The Consumer Expectations Survey points to the growing attractiveness of housing as an investment. In addition, according to the European Commission’s consumer survey, both the intentions of households to purchase or build a home and their intentions to carry out home improvements improved in the first quarter of 2026. While housing investment appears to be comparatively less exposed to the immediate impact of the conflict in the Middle East than other demand components, higher construction costs and renewed uncertainty could still have a negative effect if the shock proves to be persistent.

Chart 8

Real investment dynamics and survey data

a) Business investment

(quarter-on-quarter percentage changes; percentage balances and diffusion index)

b) Housing investment

(quarter-on-quarter percentage changes; percentage balances and diffusion index)

Euro area exports remain constrained by US tariffs, the past appreciation of the euro and weak global demand. Total euro area exports fell by 0.4% in the fourth quarter of 2025, mainly driven by a moderate decrease in goods exports of 0.9%, quarter on quarter. This reflects a reversal of the surge in pharmaceutical exports from Ireland to the United States seen in September last year. Exports to China also fell, amid competitive pressures in the Chinese market. The war in the Middle East risks disrupting trade as well as oil flows, which could further weigh on euro area trade. Total imports saw a modest decrease of 0.2% in the fourth quarter of 2025, driven by a decrease in services imports of 0.6%, quarter on quarter. At the same time, import prices continued to decline, falling by 2.3% in November in annual terms, reflecting the impact of the past appreciation of the euro and downward price pressures from China. Looking ahead survey indicators continue to signal weakness in new export orders for both manufacturing and services.

The war in the Middle East is weighing on real incomes and confidence. This has led to a downward revision of consumption and investment in the baseline staff projections, especially for 2026. The impact would be even more pronounced in alternative scenarios with a more severe and prolonged energy shock. For 2026 the effects of the conflict imply lower GDP growth, reflecting the shocks to energy prices, confidence and uncertainty. While the impact of the energy shock is assumed to be temporary, in line with market-based expectations at the cut-off date of 11 March, the outlook remains supported by additional government spending on infrastructure and defence, healthy private sector balance sheets and a robust labour market. Annual real GDP growth is projected to be 0.9% in 2026, 1.3% in 2027 and 1.4% in 2028. Compared with the December 2025 projections, GDP growth has been revised down by 0.3 percentage points in 2026 and by 0.1 percentage points in 2027. Given the very high levels of uncertainty and that the impact of the conflict will depend strongly on its duration and intensity, the baseline should be interpreted as one of several plausible outcomes, rather than the most likely one. To assess the downside risks to the baseline, some illustrative alternative scenarios have been developed, reflecting different assumptions about the duration, intensity and economic transmission of the conflict. The scenario analysis suggests that a prolonged disruption in the supply of oil and gas would result in GDP growth being below the baseline projections.

3 Prices and costs

Annual euro area headline inflation, as measured by the Harmonised Index of Consumer Prices (HICP), continues to stand close to the Governing Council’s 2% medium-term target. It increased to 1.9% in February 2026, from 1.7% in January, driven by an increase in energy inflation and HICP excluding energy and food (HICPX), while food inflation decreased.^[7] HICPX inflation increased to 2.4% in February from 2.2% in January, driven by an increase in both goods and services inflation. Indicators of underlying inflation have changed little over recent months and remain consistent with our 2% medium-term target. The annual growth in compensation per employee decreased to 3.7% in the fourth quarter of 2025, from 4.0% the quarter before. This brings the growth in compensation per employee to 3.9% in 2025, down from the 4.5% recorded in 2024.

The March 2026 ECB staff macroeconomic projections for the euro area foresee headline inflation increasing from 2.1% in 2025 to 2.6% in 2026, before declining to 2.0% in 2027 and then ticking up to 2.1% in 2028. Compared with the December 2025 projections, headline inflation has been revised up reflecting consequences of the war in the Middle East. Given the very high levels of uncertainty and the strong dependence of the inflation outlook on the duration and the intensity of the conflict, the baseline is accompanied by some alternative illustrative scenarios that are published with the staff projections on the ECB’s website.^[8]

Euro area HICP inflation increased to 1.9% in February 2026, up from 1.7% in January (Chart 9). This increase was driven by developments in energy inflation and HICPX, while food inflation edged down. The annual rate of change in energy prices remained negative albeit less so, at ‑3.1% in February compared with ‑4.0% in January, reflecting an upward base effect. Food inflation declined slightly from 2.6% in January to 2.5% in February. Within food, the annual rate of change in processed food prices fell to 1.8% in February, down from 2.0% in January, offsetting an increase in unprocessed food prices to 4.6%, from 4.2% over the same period. HICPX inflation picked up to 2.4% in February from 2.2% in January. This reflects an increase in both non-energy industrial goods (NEIG) inflation and services inflation. The rise in NEIG inflation from 0.4% in January to 0.7% in February, stemmed mainly from garments, motor cars, jewellery and watches, computers and other information and communication equipment. Services inflation went up to 3.4% from 3.2% over the same period. The increase was driven by the recreation subcomponent – particularly accommodation – and transport, partially offset by slightly lower rates in miscellaneous and housing services.

Chart 9

Headline inflation and its main components

(annual percentage changes; percentage point contributions)

Most measures of underlying inflation increased slightly in February (Chart 10).^[9] Among these measures only HICP inflation excluding food and energy, travel-related items and clothing remained unchanged. Temporary factors, like the Olympics, may have affected some of the measures. All model-based measures recorded an increase. The Persistent and Common Component (PCCI) of Inflation rose to 2.1% in February up from 1.8% in January. At the same time, the Supercore indicator, which comprises HICP items sensitive to the business cycle, increased to 2.6% from 2.5%.

Chart 10

Indicators of underlying inflation

(annual percentage changes)

Before the escalation of the war in the Middle East, indicators of pipeline pressures pointed to an easing of inflationary pressures at the later stages of the pricing chain (Chart 11). At the early stages of the pricing chain, energy producer price inflation fell further into negative territory, down to ‑8.9% in January 2026 from ‑8.4% in December 2025. However, pressures remain elevated for intermediate goods , owing to increases in domestic producer prices and import prices. Overall, at the later stages of the pricing chain, pipeline pressures on consumer goods signalled easing, with both import price (-3.6%) and domestic producer price inflation for non-food consumer goods (1.6%) declining. At the same time, manufactured food producer prices also decreased (0.6%) and manufactured food import prices continued to fall, declining from a peak of 10.6% in January 2025 to ‑3.6% a year later. These dynamics reflect the past appreciation of the euro and, possibly, China’s increased focus on the euro area as an export market. These data precede the recent start of the war in the Middle East. Developments in energy and food prices in particular, as well as pipeline pressures more broadly, are therefore being closely monitored.

Chart 11

Indicators of pipeline pressures

(annual percentage changes)

Domestic cost pressures, as measured by growth in the GDP deflator, increased to 2.5% in the fourth quarter of 2025 up from 2.4% in the previous quarter (Chart 12). This reflects an uptick in the contribution from unit profits (up from 0.3 percentage points to 0.5 percentage points), while the contributions from unit labour costs and unit net taxes remained unchanged. In growth rate terms, while the annual growth rate of unit profits rose sharply, that of unit labour costs fell marginally. This decrease was driven by a decline in the growth rate of compensation per employee (from 4.0% to 3.7%), which was partially offset by a drop in labour productivity growth (from 0.8% to 0.6%). The fall in the annual growth rate of compensation per employee reflected a decline in the contribution from the wage drift component, down to 0.4 percentage points in the fourth quarter of 2025 from 1.9 percentage points in the third quarter, partially offsetting an increase in negotiated wage growth, up to 3.0% from 1.9% over the same period. Looking ahead, the ECB wage tracker, which has been updated with data on wage agreements negotiated up to the end of February 2026 stood at 2.6% (revised down by 0.1 percentage points compared to the previous release of the wage tracker). This suggests that negotiated wage growth pressures will ease in the first half of 2026 and stabilise at lower levels in 2026.^[10] The March 2026 ECB staff macroeconomic projections expect the annual growth rate for compensation per employee to slow from 3.9% on average in 2025 to 3.1% in the fourth quarter of 2026, and then to remain broadly around this level in 2027 and 2028.

Chart 12

Breakdown of the GDP deflator

(annual percentage changes; percentage point contributions)

During the review period from 18 December 2025 to 18 March 2026, short-term market-based measures of inflation compensation (Chart 13, panel a) soared as a result of the rise in energy prices related to the war in the Middle East, while longer-term inflation expectations remained firmly anchored at 2%. After a prolonged period of low volatility, near-term market-based measures of inflation compensation were priced markedly higher owing to the surge in energy prices following the outbreak of the war in the Middle East. A key factor shaping the repricing was the uncertainty surrounding the scale and duration of the conflict. By the end of the review period, the one-year forward inflation-linked swap rate one year ahead had reached 2.1%, around 40 basis points higher than at the start of the review period. For medium and longer-term maturities, movements in inflation compensation were more contained. Specifically, the five-year forward inflation-linked swap rate five years ahead increased by around 10 basis points on the back of changes in both inflation risk premia and expectations. However, once adjusted for inflation risk premia, the market-based measure of longer-term inflation expectations remained firmly anchored at 2%, supporting the stabilisation of inflation around the Governing Council’s inflation target over the medium term. In both the ECB Survey of Professional Forecasters for the first quarter of 2026 and the ECB Survey of Monetary Analysts for March 2026, average and median longer-term inflation expectations remained at 2%.

Consumers’ perceptions of past inflation, as well as their short and medium-term inflation expectations, either remained stable or decreased in February 2026 (Chart 13, panel b). The ECB Consumer Expectations Survey (CES) fieldwork closed on 2 March; however, only 3.5% of responses were received after the start of the war in the Middle East began on 28 February. According to the CES for February 2026, the median rate of perceived inflation over the previous 12 months remained stable at 3.0%.^[11] Median expectations for inflation over the next 12 months and three years ahead both decreased to 2.5% from 2.6% in January, while median expectations for five years ahead was unchanged at 2.3%.

Chart 13

Market-based measures of inflation compensation and consumer inflation expectations

a) Market-based measures of inflation compensation

(annual percentage changes)

b) Headline HICP inflation and the ECB Consumer Expectations Survey

(annual percentage changes)

The March 2026 projections expect headline inflation to increase from 2.1% in 2025 to 2.6% in 2026 and decrease back to 2.0% in 2027, before rising again to 2.1% in 2028 (Chart 14). The near-term profile is influenced by the recent escalation of the war in the Middle East, which has pushed up energy prices. Accordingly, headline inflation is expected to follow the surge in energy inflation in the first half of 2026, increasing from 2.1% in first quarter of 2026 to 3.1% in the second quarter, and then to decelerate to 2.7% in the second half of the year. The higher average rate projected for 2026 is related to the energy surge and to an increase in food inflation later in the year owing to rising pipeline pressures from energy prices and other input costs. HICPX is expected to stabilise around 2.3%, with indirect effects from energy inflation expected to be limited. The decrease in headline inflation in 2027 mainly reflects downward base effects and falling energy prices. HICPX inflation is expected to moderate slightly, while food inflation increases further. Headline inflation is then expected to rise in 2028, driven mainly by a significant increase in energy inflation, driven by climate transition-related fiscal measures, in particular the introduction of the ETS2 scheme. Compared with the December 2025 projections, headline HICP inflation has been revised up by 0.7 percentage points for 2026 mainly owing to energy inflation, with much smaller upward revisions for 2027 and 2028 owing to the non-energy components. The upward revision to headline inflation in 2027 and 2028 reflects the delayed pass-through of higher cost pressures from higher energy prices to the HICPX and food components. HICPX inflation is expected to remain somewhat more persistent but to nevertheless moderate by 0.1 percentage points in each year of the horizon, falling from 2.4% in 2025 to 2.1% in 2028. The upward revisions to food and HICPX inflation in part reflect a limited upward adjustment based on staff judgement to capture stronger pass-through effects from higher energy prices, which may be underestimated slightly by the standard modelling tools in the context of large shocks to energy prices. Given the very high levels of uncertainty and the strong dependence on the duration and the intensity of the conflict, the baseline should be interpreted as one of several plausible outcomes, rather than the most likely one. To assess the risks to the baseline, some illustrative alternative scenarios have been developed, reflecting different assumptions about the duration, intensity and economic transmission of the conflict. The scenario analysis highlights that a prolonged disruption to energy supply, combined with stronger second-round effects, could lead to more persistent inflationary pressures over the medium term.

Chart 14

Euro area HICP and HICPX inflation

(annual percentage changes)

4 Financial market developments

Euro area financial markets experienced a sharp and volatile repricing towards the end of the review period, which ran from 18 December 2025 to 18 March 2026, triggered by the outbreak of the war in the Middle East at the end of February. This repricing was marked by a surge in energy prices and a sell-off in equity markets, alongside higher inflation compensation and expectations of rising interest rates. Uncertainty surrounding the breadth and duration of the conflict has been a key factor shaping both recent and prospective market developments. At the end of the review period, the risk-free euro short-term rate forward curve was pricing in around 50 basis points of cumulative interest rate hikes in the euro area by the end of 2026. Long-term sovereign bond yields moved higher and yield spreads widened amid increased risk aversion, although the dispersion of yields across euro area countries remained low. While euro area equities proved resilient overall, the sell-off following the start of the war was particularly pronounced in sectors that are highly reliant on energy. Corporate bond spreads widened in response to war-related uncertainty. In foreign exchange markets, the euro depreciated both against the US dollar (-1.9%) and in trade-weighted terms (-1.6%), which was partly related to energy-driven terms of trade shocks triggered by the war in the Middle East.

Euro area short and long-term risk-free rates increased during the review period, amid heightened volatility driven by the outbreak of the war in the Middle East (Chart 15). The benchmark euro short-term rate (€STR) stood at 1.93% at the end of the review period, following the Governing Council’s decisions at its December 2025 and February 2026 meetings to keep the three key ECB interest rates unchanged. Excess liquidity decreased by around €91 billion to €2,379 billion, which mainly reflected the continuing decline in the portfolios of securities held for monetary policy purposes. While near-term forward rates initially fell between the December and February Governing Council meetings, they subsequently rebounded as a result of heightened geopolitical tensions and rising global energy prices, more than reversing the earlier decrease. The escalation of the Middle East conflict triggered a sharp repricing of near-term policy rate expectations. The latest €STR forward curve implies cumulative interest rate hikes of 50 basis points by the end of the year. Looking beyond 2027, the upward shift in the €STR forward curve persists amid a high level of uncertainty surrounding the duration of the conflict and a volatile energy market. Overall, the ten-year nominal overnight index swap (OIS) rate increased by around 10 basis points to 2.8% over the review period.

Chart 15

€STR forward rates

(percentages per annum)

Long-term sovereign bond yields moved higher and yield spreads widened somewhat as a result of increased risk aversion towards the end of the review period (Charts 16 and 17). The ten-year GDP-weighted euro area sovereign bond yield rose by around 15 basis points, closing the review period at around 3.3%. Earlier in the review period, ten-year sovereign yields across the euro area broadly tracked the risk-free OIS rate (Chart 17). After the start of the war in the Middle East, spreads relative to the risk-free rate widened across most euro area countries but narrowed marginally for Germany, which benefited from safe-haven flows. However, yield dispersion, measured by the cross-sectional standard deviation of sovereign yields, remained close to the relatively low levels observed before the global financial crisis. In the United States, the ten-year Treasury yield increased by around 15 basis points to stand at 4.3% at the end of the review period, in line with a broader global repricing of sovereign bonds triggered by the heightened geopolitical tensions.

Chart 16

Ten-year sovereign bond yields and the ten-year OIS rate based on the €STR

(percentages per annum)

Chart 17

Ten-year euro area sovereign bond spreads vis-à-vis the ten-year OIS rate based on the €STR

(percentage points)

Euro area equities experienced a significant sell-off amid rising risk aversion following the start of the war, largely offsetting the substantial gains recorded earlier in the review period (Chart 18). Overall, euro area stock market indices proved resilient, with the sub-index for non-financial corporations (NFCs) rising by 0.8%. By contrast, bank stocks declined by 5.2%, amid a flattening of the yield curve. In the United States, the broad equity market index went down by 2.3%, with the indices for NFCs and banks falling by 1.6% and 9.6% respectively. Earlier in the review period, concerns about the overvaluations of artificial intelligence companies in the United States weakened the comovement between US and euro area equity markets, with euro area stocks outperforming their US counterparts. The outbreak of the war in the Middle East triggered a rise in market volatility and a deterioration in risk sentiment, prompting a market sell-off on both sides of the Atlantic. Given the euro area’s greater reliance on energy imports, euro area equities were affected to a greater extent than their US counterparts.

Chart 18

Euro area and US equity price indices

(index: 2 January 2020 = 100)

In corporate bond markets, spreads on euro area investment-grade and high-yield bonds remained compressed earlier in the review period, before widening somewhat after the outbreak of the war in the Middle East. Risk appetite remained robust overall, although it deteriorated following the outbreak of the conflict, contributing to wider corporate bond spreads towards the end of the review period. The widening was most pronounced in the euro area high-yield segment, where spreads increased by about 30 basis points. At the same time, investment-grade corporate spreads widened by approximately 10 basis points for both NFCs and financial firms.

In foreign exchange markets, the euro depreciated both against the US dollar and in trade-weighted terms (Chart 19). The nominal effective exchange rate of the euro – as measured against the currencies of 40 of the euro area’s most important trading partners – fell by 1.6% over the review period. This decline reflected a weakening of the euro against the currencies of many of the euro area’s major trading partners. Notably, the euro depreciated against the US dollar (-1.9%), to USD 1.15 per euro. The euro initially strengthened in January 2026, but later weakened owing to the broad-based strengthening of the US dollar amid heightened geopolitical tensions and energy-related concerns triggered by the war in the Middle East. The euro also depreciated against the Chinese renminbi (-4.0%), which gained strength gradually throughout the review period, partly reversing the euro’s earlier gains against the currency in early 2025. Similarly, the euro lost ground against the pound sterling (-1.2%), the Swiss franc (-2.6%), and the Brazilian real (-7.6%), reflecting rising uncertainty stemming from the war in the Middle East. By contrast, it remained broadly stable against the Japanese yen (+0.5%) and appreciated against the Polish zloty (+1.6%) and the Turkish lira (+1.5%).

Chart 19

Changes in the exchange rate of the euro vis-à-vis selected currencies

(percentage changes)

5 Financing conditions and credit developments

Financing conditions for firms and households were broadly stable up to January 2026, but have tightened since the last Governing Council meeting following the outbreak of the war in the Middle East. In January, bank lending rates for firms remained at 3.6%, while the average interest rate on new mortgages edged up to 3.4%. Growth in loans to firms decreased somewhat, while growth in loans to households was stable. The annual growth in broad money (M3) increased to 3.3%. Over the review period from 18 December 2025 to 18 March 2026, the cost to non-financial corporations of both market-based debt and equity increased, as did bank bond yields.

Bank funding costs remained broadly stable up to January 2026, but bank bond yields underwent a sharp repricing in early March. The composite cost of debt financing for euro area banks stood at 1.5% in January, unchanged at this level since July 2025 (Chart 20). Bank bond yields were stable in January, having hovered around 3% since early 2025. However, preliminary data available up to 18 March 2026 indicate that they increased sharply (by approximately 40 basis points) following the outbreak of the war in the Middle East on 28 February, and were likely to continue to put upward pressure on bank funding costs. The composite deposit rate also remained stable at 0.9% in January. Interest rates on overnight deposits, deposits redeemable at notice and interbank rates saw little change, while rates on time deposits for firms decreased slightly.

Chart 20

Composite bank funding costs in the euro area

(annual percentages)

Bank lending rates for firms were stable in January, while those for households increased marginally (Chart 21). The cost of bank borrowing for non-financial corporations was unchanged at 3.6% in January, around 1.7 percentage points below its October 2023 peak. Across rate fixation periods the picture was mixed: rates on short-term loans (up to one year) declined slightly, while rates on loans with intermediate fixation periods (over one year and below five years) increased marginally. The spread between interest rates on small and large loans to firms was unchanged and close to historical lows. The cost of borrowing for households for house purchase increased marginally to 3.4% in January, from 3.3% in December, and stood around 70 basis points below its November 2023 peak. Across rate fixation periods, this development was driven by rates on longer-term mortgages (above five years), with rates on short-term mortgages (below one year) recording a small decline.

Chart 21

Composite bank lending rates for firms and households in the euro area

(annual percentages)

Over the review period from 18 December 2025 to 18 March 2026, the cost of both market-based debt and equity financing increased. The overall cost of financing for non-financial corporations – the composite cost of bank borrowing, market-based debt and equity – remained stable in January for the third consecutive month, at 5.8% (Chart 22).^[12] The lower cost of market-based debt was compensated by a slight increase in the cost of long-term bank borrowing, while all other components remained virtually unchanged. However, daily data for the period from 18 December 2025 to 18 March 2026 show an increase in the cost of both market-based debt and equity financing. The increase reflects a widening of corporate spreads – especially in the high-yield sector – and a rise in the equity risk premium. Risk-free rates also increased across the maturity spectrum – most noticeably at the short end – amid significant intra-period volatility.

Chart 22

Nominal cost of external financing for euro area firms, broken down by component

(annual percentages)

Growth in loans to firms decreased somewhat in January, while growth in loans to households was stable (Chart 23). The annual growth rate of bank lending to non-financial firms slowed to 2.8% in January, from 3.0% in December, well below its historical average of 4.3% since 1999. This was offset by an increase in issuance of debt securities by firms, with the annual growth rate rising to 4.0%, from 3.5% in December. The annual growth rate of loans to households was stable at 3.0% in January, also remaining well below its historical average of 4.1%. The growth of loans to households was supported mainly by growth in mortgages and consumer credit, while other forms of lending to households, including loans to sole proprietors, remained subdued. The modest growth in loans to firms and households reflects several factors, such as heightened uncertainty surrounding the economic outlook and low risk appetite among banks, amid elevated geopolitical risks.^[13]

Chart 23

MFI loans in the euro area

(annual percentage changes)

The annual growth rate of broad money (M3) increased in January, reflecting a rebound in foreign inflows into the euro area (Chart 24). M3 growth rose to 3.3% in January, from 2.8% in December, but remained well below its long-term average of 6.1%. Looking at the components, the recovery in money growth was explained by a stronger preference for liquid assets, especially among non-bank financial intermediaries. This was indicated by an increase in the annual growth rate of narrow money (M1) – comprising the most liquid instruments, namely currency in circulation and overnight deposits – from 4.7% in December to 5.3% in January. As regards the counterparts of M3, the development was primarily driven by a rebound in net foreign monetary inflows and an increase in bank purchases of (shorter-term) government bonds. By contrast, the Eurosystem balance sheet continued to weigh on M3 growth, given that the principal payments from maturing securities in the asset purchase programme and pandemic emergency purchase programme portfolios are no longer reinvested.

Chart 24

M3, M1 and overnight deposits

(annual percentage changes, adjusted for seasonal and calendar effects)

6 Fiscal developments

According to the March 2026 ECB staff macroeconomic projections, the euro area general government budget deficit is estimated to have remained unchanged at 3.1% of GDP in 2025 and is expected to increase to 3.6% in 2027 and 2028. After a slight loosening in 2025, the euro area fiscal stance is projected to loosen more strongly in 2026 and to tighten somewhat over 2027-28. The euro area debt-to-GDP ratio is projected to increase from 87.5% in 2025 to 89.5% in 2028. Strengthening the euro area economy while maintaining sound public finances remains essential. In the current geopolitical environment, governments should prioritise sustainable public finances, strategic investment and growth-enhancing structural reforms. Any fiscal responses to the energy price shock triggered by the war in the Middle East should be temporary, targeted and tailored. The current energy crisis underscores the imperative to further reduce dependence on fossil fuels.

According to the March 2026 ECB staff macroeconomic projections, the euro area general government budget deficit should be unchanged at 3.1% of GDP in 2025, increase to 3.6% in 2027 and remain at that level in 2028 (Chart 25).^[14] Compared with the December 2025 Eurosystem staff macroeconomic projections, the projected budget balance has been revised upwards over the entire projection horizon. The revisions primarily reflect a worsening of the cyclically adjusted primary balance, mainly owing to upward adjustments to pensions and other expenditures reflecting higher inflation as a result of the conflict in the Middle East. The increase in the deficit mainly reflects a rising interest payments-to-GDP ratio (by about 0.4 percentage points over the forecast horizon), followed by a deterioration in the cyclically adjusted primary balance, which is only slightly compensated by an improvement in the cyclical component at the end of the projection horizon. The increase in interest payments reflects the pass-through of past interest rate rises, which is progressing slowly owing to the long residual maturities of outstanding sovereign debt. In addition, the expiration of the Next Generation EU (NGEU) programme will end the flow of commonly financed grants that EU Member States received, while some of the investments related to previously disbursed funds will still take place.

Chart 25

Budget balance and its components

(percentages of GDP)

After a slight loosening in 2025, the euro area fiscal stance is projected to loosen more strongly in 2026 and to tighten somewhat over 2027-28.^[15] The estimated annual change in the cyclically adjusted primary balance, adjusted for grants extended to countries under the NGEU programme, shows a slight loosening of fiscal policies in the euro area in 2025 (by -0.1 percentage points of GDP). The projected loosening in 2026 is mainly on account of higher public investment and fiscal transfers. The increase in investment primarily reflects high defence and infrastructure spending in Germany (as well as in other smaller countries) and, to a lesser extent, NGEU-funded investment. In 2027 and 2028, consolidation in many countries, including Spain, France and Italy, and the expiry of NGEU funding are broadly offset by stimulus, mainly in Germany.

The euro area debt-to-GDP ratio is set on a rising path from 87.5% in 2025 to 89.5% in 2028 (Chart 26). The euro area debt-to-GDP ratio is projected to increase as the continuing primary deficits and positive deficit-debt adjustments outweigh the favourable, though diminishing, effects of interest rate-growth differentials. Compared with the December projections, the government debt path has been revised upwards, reflecting higher cumulative primary deficits and less favourable interest rate-growth differentials.

Chart 26

Drivers of change in the euro area government debt-to-GDP ratio

(percentage points)

Strengthening the euro area economy while maintaining sound public finances remains essential. In the current geopolitical environment, governments should prioritise sustainable public finances, strategic investment and growth-enhancing structural reforms. Unlocking the full potential of the Single Market remains crucial. It is also vital to foster greater capital market integration by following an ambitious timetable for completing the savings and investments union and the banking union and to rapidly adopt the Regulation on the establishment of the digital euro. Any fiscal responses to the energy price shock triggered by the war in the Middle East should be temporary, targeted and tailored. The current energy crisis underscores the imperative to further reduce dependence on fossil fuels.

Boxes

1 Where do the costs of higher US tariffs fall?

Prepared by Stefan Schaefer, Lisa Gerland and Marcel Tirpák

Understanding the impact of tariffs on inflation is a complex task as it involves analysing responses along the pricing chain, including those by foreign exporters, distributors, producers and retailers. At different stages of this pricing chain, domestic firms could respond to tariff announcements by building up inventories before tariffs are implemented, shifting the sourcing of their imports from countries facing higher tariffs to countries facing lower tariffs (trade diversion) and adjusting the pricing of their products to accommodate the impact of tariffs. This analysis is made all the more intricate by exchange rate developments and exemptions for goods in transit at the time of tariff implementation. In this box, we estimate the impact of recently imposed US tariffs on the prices exporters are charging for products delivered to the United States and explore differences in the pricing behaviour of exporters across countries and sectors observed to date. We show that the costs of tariffs are falling mostly on US firms and consumers and only 5% of costs are borne by foreign firms.

2 Unlocking trade potential: the benefits of improving cross-border payments

Prepared by Massimo Ferrari Minesso, Laura Lebastard and Olga Triay Bagur

International trade could not happen without cross-border payments. Payment systems are the backbone of the financial infrastructure – the critical “plumbing” that underlies the functioning of modern economies by enabling the clearing and settlement of international transactions. This box aims to evaluate the economic benefits of technological innovations in cross-border payments by considering the case of interlinking fast payment systems between countries.

3 Non-linearities in oil prices: which conditions matter?

Prepared by Vlad Burian and Arthur Stalla-Bourdillon

Different oil market states can significantly affect how oil prices respond to shocks. Over recent years oil prices have reacted strongly when key variables, referred to here as “state variables”, reach extreme levels. During the COVID-19 pandemic, for example, the collapse in oil prices linked to the Russia-Saudi Arabia price war was likely amplified by elevated inventories, which limited the capacity to absorb excess supply. A similar amplification mechanism was observed in October 2024, when Iran’s strike on Israel surprised the markets. Investment funds, which were short by historical standards, rapidly unwound positions, thus intensifying the price increase.^[16] Oil price volatility appears to be higher when three state variables – managed money positions (derivative positions held by investment funds), supply-demand imbalances (the difference between global oil supply and demand) and OECD inventories – reach extreme levels (Chart 1).^[17]

4 How is trade policy uncertainty affecting euro area activity?

Prepared by Alina Bobasu and Beatrice Pierluigi

Trade policy uncertainty has risen significantly in recent years, reaching historically high levels throughout the past year. It initially rose during the US-China trade conflict in 2018-19, under the first Trump Administration, and intensified again around the 2024 US presidential election and the start of the second Trump term, when trade policy moved to the centre of the US economic agenda. A series of tariff announcements in early 2025 marked a major policy shift that pushed trade policy uncertainty to a peak well above the levels seen during the 2018-19 trade dispute (Chart A).^[18] Uncertainty eased somewhat following the US-China trade truce in May 2025 and the US-EU framework agreement in late July of the same year, but it has remained elevated by historical standards. This persistent uncertainty weighed on euro area activity during 2025 and continues to pose risks, given the region’s deep integration into global trade networks. In the second half of 2025 and early 2026, renewed trade tensions between the United States and China, together with the events related to Greenland, illustrated that further episodes of heightened trade policy uncertainty remain likely. This box outlines the channels through which trade policy uncertainty affects euro area activity, estimates its impact so far and discusses the factors that have supported resilience despite the challenging global environment.

5 From bricks to clicks: an assessment of euro area digital investment

Prepared by Malin Andersson, Sara Colombo, Valerie Jarvis and Richard Morris

Euro area business investment has been relatively muted in recent years, with its components displaying a two-speed dynamic. While overall investment performance has been modest, investment in tangible assets and investment in intangible assets have shown diverging trends since 2020 (Chart A). At the end of 2025, intangible assets – which encompass intellectual property products (IPP) including computer software and databases as well as research and development (R&D) – accounted for around 80% of the cumulative expansion in business investment recorded since the fourth quarter of 2019. This is despite representing only around two-thirds of the capital expenditure on tangible assets, which include machinery and equipment. This widening gap has likely been driven by the strong rise in investment in digital assets. Against this background, this box examines the evolution of digital investment in the euro area by using proxies that track the main digital-related asset categories. It also discusses the economic implications of the growing share of digital investment in overall euro area business investment.

6 Adopting and investing in AI: evidence from euro area firms in the SAFE

Prepared by Annalisa Ferrando, Sara Lamboglia, Judit Rariga and Maurice Schmidt

This box presents new information about the adoption of artificial intelligence (AI) technologies by euro area firms, and about their plans for AI investment up to the end of 2026. The Survey on the Access to Finance of Enterprises (SAFE) for the fourth quarter of 2025 (ECB, 2026) included a set of ad hoc questions about the adoption of AI and the reasons for using, or not using, these technologies. Firms were asked about the extent of their adoption of specific technologies, including predictive tools (such as text mining, voice and image recognition, and machine learning), generative tools (such as chatbots and text/image generation) and robotic process automation. They were then asked to indicate their investment plans in AI over the next 12 months and to assess the diffusion of AI investment among their competitors in their own country up until June 2025.^[19]

7 Financial and macroeconomic implications of the rise in very long-term yields

Prepared by Tilman Bletzinger, Ambra Boilini, Christoph Kaufmann, Giulio Nicoletti, Melina Papoutsi and Johannes Pöschl

Very long-term interest rates have risen significantly in several advanced economies over the past year, leading to a steepening of the slope at the very long end of the yield curve (Chart A). In the euro area, this steepening of the 30‑year to ten‑year slope has been relatively pronounced compared with previous episodes, reflecting a move towards more normally shaped yield curves amid higher long-term real rates, global factors and a fiscal repositioning of euro area countries (Böninghausen and Vladu, 2026). This box studies the implications of the steepening of the long-end yield curve for government funding costs, private-sector portfolios, bank lending and macroeconomic performance.

8 Liquidity conditions and monetary policy operations from 5 November 2025 to 10 February 2026

Prepared by Christian Lizarazo and Kristian Tötterman

This box describes the Eurosystem liquidity conditions and monetary policy operations in the seventh and eighth reserve maintenance periods of 2025. Together, these two maintenance periods ran from 5 November 2025 to 10 February 2026 (the “review period”).

Article

1 Boosting efficiency in public investment in times of fiscal constraint

Prepared by Stephan Haroutunian, Carolin Nerlich, Marta Rodríguez-Vives and Caspar Schauhoff

The European Union (EU) is faced with massive strategic public investment needs in an environment of limited fiscal space. Europe will have to scale up its strategic investments, especially in the fields of digitalisation, infrastructure, climate change and defence. While the private sector is expected to play a crucial role in financing these needs, the public sector will also have to step up its investments, especially given the leading role it plays in certain domains, such as infrastructure and defence. These strategic investment needs coincide with limited fiscal space, given that public debt and deficit levels are high in many EU counties, most notably in some large euro area countries, and that public spending linked to ageing populations is rising. Governments have had to intervene to stabilise the economy following repeated shocks, but some of them have also failed to make use of good economic times to build up fiscal buffers. As a result, they are now faced with significant fiscal adjustment requirements.

Statistics