Yael Selfin, Chief Economist at KPMG UK, said: “Europe’s economy has remained resilient, but the sources of that are changing. Higher prices and concerns about job security are making households more cautious, while investment in AI, defence and infrastructure is expected to play a greater role in supporting growth.
“The recovery remains vulnerable to further energy price shocks. Some of the buffers that helped households and governments absorb the initial disruption have already been drawn down, leaving less room to cushion another setback.”
Investment to take a greater role as consumer spending slows
Consumer spending supported eurozone growth in the first half of 2026, helped by lower household savings rates and fiscal measures dampening the impact of rising living costs.
However, this is unlikely to continue at the same pace. Higher inflation is eroding purchasing power, while increased uncertainty around job security is expected to encourage households to save more. Some spending, particularly on new cars, also appears to have been brought forward ahead of anticipated price increases, potentially weakening demand in the near term.
KPMG expects consumption to recover towards the end of 2027 and into 2028 as inflation subsides and household purchasing power strengthens.
Meanwhile, investment is expected to become an increasingly important source of growth. Germany’s public spending on infrastructure and defence is likely to support activity over the medium term and generate positive spillovers for the private sector.
Yael added: “Investment offers an important source of support as consumer spending loses momentum. Germany’s infrastructure and defence programmes, alongside AI-related spending across Europe, should help strengthen activity.”
Inflation to ease, but energy and food prices keep pressure on households
Eurozone inflation is expected to peak at around 3.8% in the final quarter of 2026 before moderating through 2027 as energy price pressures fade.
Inflation is forecast to average 3.1% in both 2026 and 2027, with rising food prices likely to slow its return to the ECB’s 2% target. Elevated energy costs, drought conditions in Europe and the potential impact of El Niño on crop yields could add to food price pressures during 2027. KPMG expects inflation to return to target by the end of 2027 or early 2028.
ECB tightening cycle set to continue
The ECB is expected to raise rates twice more, in December 2026 and March 2027, taking the deposit rate from 2.5% to 3.0%.
With headline inflation elevated and economic activity remaining resilient, further tightening is expected in the near term. However, limited evidence of broader inflationary pressures and the tightening effect of higher bond yields should reduce the need for rates to rise beyond 3.0%.
Labour markets are expected to soften gradually, with eurozone unemployment forecast to average 6.4% in both 2026 and 2027. Conditions vary across Europe: Finland and Sweden have experienced relatively high and rising unemployment, while Spain, Greece and Portugal continue to record strong employment growth.
Fiscal pressures leave an uneven outlook across Europe
Rising debt-servicing costs and growing demands for spending on defence, infrastructure and ageing populations are putting increasing pressure on European public finances.
Germany’s relatively strong fiscal position is allowing it to support growth through investment, while countries with weaker public finances face more difficult choices over spending and consolidation. France has experienced particularly pronounced increases in borrowing costs.
Growth is forecast to reach 1.2% in Germany and 0.7% in France in 2027. Spain is expected to remain one of the stronger-performing major eurozone economies, with growth of 2.3%, while Italy is projected to expand by 0.4%.
Yael added: “The scope to support growth differs considerably across Europe. While Germany can increase investment, governments facing higher borrowing costs and weaker public finances have less room to respond.
“The challenge is to sustain investment while managing growing spending pressures. Stronger productivity growth will be important in easing that trade-off over the longer term.”
