Global Insight 2026 Outlook: Europe

By Frédérique Carrier; Rufaro Chiriseri, CFA; Thomas McGarrity, CFA

Europe equities

Europe is facing opposing macroeconomic forces. On one hand, U.S. tariffs and a strong euro are squeezing the export sector, while Chinese competition is intensifying. Countries such as Germany and Italy, with their large industrial export sectors, are pinched the most.

On the other hand, powerful forces are providing a reflationary lift: loose monetary policy, with the European Central Bank (ECB) having cut its benchmark interest rate in half to two percent since mid-2024; expansionary fiscal policies in some countries, with Germany’s 10-year €500 billion infrastructure programme being the highlight; and the implementation of structural reforms.

Overall, we believe evidence points to domestic reflationary forces winning. After all, the eurozone region has been growing modestly, beating slower-growth market expectations, and export-exposed countries seem to have avoided recession in 2025. RBC Capital Markets has penciled in 1.5 percent growth for the region in 2026 as Germany’s infrastructure investment and defence spending are expected to contribute in earnest.

Progress on structural reforms could underpin growth further. The European Policy Innovation Council found that only some 11 percent of former ECB President Mario Draghi’s 383 recommendations for reform have been fully implemented. A year ago, he urged EU leaders to address the bloc’s ongoing productivity shortfall by deepening the single market, boosting innovation and diversifying supply chains.

Much remains to be done. Unfortunately, political instability in France could hold back progress. Discussions of common borrowing to fund defence and scientific research, as Draghi had suggested, will be hard to advance so long as the EU’s second-largest economy has not put its public finances in order. Any delay in the implementation of Germany’s infrastructure plan would also limit growth prospects.

Less than one-third of Draghi’s reforms have been fully or partially implemented

Percentage of measures at various stages of implementation as of Sept. 4, 2025

The STOXX Europe 600 ex UK Index – our preferred proxy for eurozone equities – trades at 14.8x 2026 consensus earnings estimates. That is slightly above its long-term average, a premium we believe is warranted given the region’s fiscal impulse is improving the medium-term growth outlook.

We continue to prefer sectors we think are likely to benefit from fiscal stimulus, such as select Industrials, including defence, and Materials. In our view, banks should benefit from the region’s improved medium-term growth outlook, while continuing to provide attractive dividends and share buyback opportunities.

Europe fixed income

Our base case forecast calls for eurozone GDP growth of 1.6 percent in 2026, boosted by increased regional fiscal expenditures, notably the loosening of the German fiscal brake and €500 billion in infrastructure spending that Germany is planning over the next decade. This should lead to a modest uptick in inflation, keeping the European Central Bank’s (ECB) monetary policy rate at two percent. The risks to our base case are tariff headwinds and delays in fiscal spending, which could suppress economic growth and ultimately lead to inflation undershooting the ECB’s two percent target over the medium term.

Germany has the fiscal headroom to borrow, while France’s unpredictable political backdrop makes fiscal tightening seem like a tall order. French sovereign bond yields are likely to remain at or above Italian yields. On the other hand, Italy is on track to potentially exit the EU’s excessive deficit procedure by 2026. Elsewhere, we think the fiscal deficits of Spain, Portugal and Greece are likely to remain well controlled and these nations’ sovereign bonds should outperform in a competitive yield environment. With increased overall bond supply and our expectation that yields will trend higher in 2026, especially in Germany, we prefer an Underweight position in European sovereign bonds.

Bund yields expected to rise over the coming year

Current German Bund yields and market-implied Bund yields in a year’s time

In corporate bonds, we forecast modest widening of investment-grade credit spreads – the additional compensation for credit risk – and a more pronounced widening in high-yield spreads. While high-yield bond default rates have fallen from cycle peaks and stabilised, we project an uptrend in defaults in 2026 driven by idiosyncratic factors. Investors’ ongoing robust demand for yield and fiscal expansion should remain supportive for credit spreads, and we expect the high-yield sector to outperform the investment-grade space. Within investment-grade, we think opportunities remain in the Autos sector due to attractive valuations versus historical averages and relatively strong balance sheets. For similar reasons, we think there are compelling opportunities in the Telecoms, Utilities and Financials sectors.

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