ECB: Headline inflation in euro zone to drop to 1.7% in 2026

Headline inflation in the euro zone, as measured by the Harmonised Index of Consumer Prices (HICP), is projected to move sideways, at around two per cent, for the rest of 2025, and then to drop to 1.7 per cent in 2026 before recovering to 1.9 per cent in 2027, according to a European Central Bank (ECB) staff macroeconomic projections for the euro area published on September 11.

The drop in 2026 reflects a further gradual easing in the non-energy components, while energy inflation is expected to remain volatile, but to rise over the projection horizon, in part because of the start of the EU Emissions Trading System 2 (ETS2) in 2027, the report said.

It said that food inflation is expected to remain elevated initially, as lagged effects from past price increases in international food commodities feed through, but to moderate to rates somewhat above two per cent in 2026 and 2027.

HICP inflation excluding energy and food (HICPX) is expected to decline as wage pressures recede and services inflation moderates, and as the appreciation of the euro feeds through the pricing chain and curbs goods inflation.

Lower wage growth, as past real wage losses have been recouped, coupled with a recovery in productivity growth, is expected to lead to significantly slower unit labour cost growth.

Compared with the June 2025 projections, the outlook for headline HICP inflation has been revised up by 0.1 percentage points for both 2025 and 2026 on account of higher energy commodity price outcomes and assumptions, as well as lagged effects from higher international food commodity prices, which more than offset the appreciation of the euro.

For 2027, the lagged effects of the appreciation of the euro are seen to predominate, resulting in a 0.1 percentage point downward revision.

Trade tariffs and related uncertainty contributed to strong fluctuations in economic activity during the first half of 2025, with frontloading of activity, especially in Ireland, the report said.

The unwinding of these factors in the second half of the year is expected to entail further volatility, blurring signals of the underlying momentum of the euro area economy.

In fact, looking through the volatility caused by the fluctuations in Irish data, economic growth in the rest of the euro area was more stable, and it is expected to remain so in the second half of the year, the report said.

Although the new US-EU trade agreement implies higher tariffs on euro area exports to the United States, it has helped to reduce trade policy uncertainty, it said.

Later in the horizon economic growth in the euro area is projected to strengthen, supported by several factors.

Rising real wages and employment, together with new government spending on infrastructure and defence, mainly in Germany, should bolster euro area domestic demand.

Furthermore, less restrictive financing conditions – mainly reflecting recent monetary policy decisions – and a rebound in foreign demand in 2027 are also seen to support the growth outlook.

Annual average real GDP growth is projected to be 1.2 per cent in 2025, 1.0 per cent in 2026 and 1.3 per cent in 2027.

Compared with the June 2025 Eurosystem staff macroeconomic projections, the outlook for GDP growth has been revised up by 0.3 percentage points for 2025, reflecting better than expected incoming data and a carry-over effect from revisions to historical data.

As not all of the data surprises relate to stronger than previously assumed frontloading of activity, they are only seen to be partly offset in the second half of the year.

The appreciation of the euro and weaker foreign demand (in part related to somewhat higher tariffs than assumed in the June projections) have resulted in a 0.1 percentage point downward revision for 2026, the report said.

(Photo: flickr.com/ kiefer)