Age of Agility: Key Themes Shaping Europe in 2026

As the EU and its allies and neighbors implement plans for 2026, governments and companies will be faced with more difficult choices given the countervailing political and economic pulls of the US and mainland China. These relationships will critically shape the Europe outlook for 2026—economic policy decisions, trading relations, access to resources, and regional security. 

• US-mainland China competition will significantly impact the EU’s trade regulations. The EU will intensify efforts to reduce reliance on mainland China for rare earth minerals.
• Geopolitical competition and protectionism will drive the EU to prioritize supply chain reliability within its industrial and security strategies. 
• The European Commission’s prior goals to advance the green energy transition face mounting political pressures that will delay or dilute regulatory frameworks under the EU Renewable Energy Directive.
• A peace agreement between Ukraine and Russia is highly unlikely in 2026. EU sanctions against Russia will probably continue. European defense spending is projected to rise. 
• Domestic demand is projected to be the primary growth driver in Western Europe for 2026. 
• The fiscal landscape in Europe will be mixed, with some countries adopting expansionary measures while others focus on consolidation.

Weaker transatlantic trade will be partially offset by exports to non-US markets. The US-EU trade deal will limit tariff uncertainty for EU exporters but leave tariff costs materially higher than before, weakening US demand for EU-origin through 2026, especially in pharmaceuticals and chemicals, which have the most frontloaded purchases over 2025.

The strategic imperative to reduce the EU’s exposure to mainland China and the US will drive EU efforts to secure preferential trade agreements with other countries through 2026. The EU will aim to secure a free-trade deal and a defense framework agreement with India at a summit on Jan. 27, 2026.

Separately, the recently concluded CEPA and IPA agreements with Indonesia will probably serve as a model for similar deals with other ASEAN members, such as Malaysia, the Philippines and Thailand. Challenges include the EU’s higher protectionist measures and the EU’s green rules affecting third countries, resulting in pressure on the EU to ease some of these regulations. This trend was evident in 2025 with the European Commission’s decision to postpone the EU Deforestation Regulation.

In 2026, NATO members must for the first time begin increasing defense spending to meet the 5%-of-GDP target agreed at the 2025 NATO Summit for achievement by 2035. Several EU members have already allocated a higher share of public expenditure to defense in their 2026 state budget drafts. Increased public spending on defense will likely have positive repercussions in the manufacturing supply chain, although benefits will be moderated by imports to offset Europe’s current lack of spare capacity in defense manufacturing.

A peace agreement between Ukraine and Russia is highly unlikely in 2026. We expect that Europe’s defense expenditure will continue upward momentum due to Europe’s continuing provision of military support to Ukraine, the halt in US financing for Ukraine’s military aid, which we assess as very unlikely to be reversed, and the EU’s efforts to reduce strategic dependence on the US.

We expect domestic demand to be the main driver of Western European growth in the Europe economic outlook for 2026. Fiscal policy will gradually contribute positively to growth. Labor market conditions are likely to remain generally supportive, despite some weakness.

Domestic demand will also benefit from past interest rate cuts, particularly by the European Central Bank (ECB), with further easing likely by the Bank of England and Norges Bank in 2026. Resilient domestic demand conditions will offset a negative contribution from net trade, as European export growth faces limitations from softer external demand, appreciating currencies, and higher tariffs on exports to the US.

We expect bank credit growth to moderate after the 2025 rate cuts, with banks maintaining a cautious risk appetite due to a notable increase in corporate bankruptcies and concerns regarding asset quality.

Across Emerging Europe, investment spending will be the main driver for growth. The final disbursements of Recovery and Resilience Facility (RRF) resources and increased lending to boost defense spending will elevate fixed capital investment in Central Europe and the Balkans (CEB). Gross fixed capital investment will outpace GDP in all but two CEB countries—Hungary and Lithuania. 

The ongoing war in Ukraine will erode growth in Ukraine and Russia, with low oil prices and increased sanctions also providing headwinds to the latter. 

The 2026 fiscal landscape in Europe is likely to vary, with some countries adopting expansionary measures to stimulate growth, while others focus on fiscal consolidation. Germany will pursue an expansionary fiscal policy, driven by increased public investment in infrastructure and defense, significantly boosting domestic demand. Expansionary fiscal policy is also likely in Poland, Greece and Norway. Conversely, fiscal policy will be tightened by varying degrees in France and the UK.

Fiscal vulnerabilities will persist, particularly in countries with weak economic growth and high debt levels. These include the UK, France, Italy, Romania and Finland. Although S&P Global Market Intelligence’s baseline projections do not include substantial widening of government bond spreads, these economies will remain vulnerable to increased borrowing costs if concerns about debt dynamics intensify. 

Divergent monetary policy relative to the US Federal Reserve is likely to support Western European currencies, which appreciated significantly against the US dollar in 2025. Rate cuts will continue in non-eurozone countries in Emerging Europe. 

—With contributions from Louise Alestam