Vanguard holds euro area growth forecast at 0.8% as ECB nears peak rates

Vanguard has kept its euro area growth forecast for 2026 steady at 0.8%, arguing that the economy has absorbed the energy shock more comfortably than many expected and that the European Central Bank is close to finishing its tightening cycle. The assessment, published on 11 August, comes from Shaan Raithatha, a senior economist at the asset manager, and paints a picture of an expansion that is neither booming nor collapsing, just grinding forward while the inflation impulse fades.

Second-quarter data surprised to the upside

The numbers behind the unchanged forecast are worth examining. Euro area GDP accelerated to 0.4% quarter on quarter in the second quarter, a pace that doubles the first-quarter reading. All four of the bloc's largest economies, Germany, France, Italy and Spain, expanded. High-frequency indicators have firmed since: the composite Purchasing Managers' Index for July climbed back above the 50 threshold that separates expansion from contraction, manufacturing output reached its highest level since early 2022, and the European Commission's economic sentiment indicator improved. Eurostat's quarterly national accounts will provide the official confirmation when they are released later this month, but the early signals are consistent with an economy that has stopped shrinking.

That resilience is notable because the geopolitical backdrop has deteriorated since Vanguard's previous outlook. The war in Ukraine has reescalated in ways that could have reignited energy market panic. Instead, European gas storage levels remain well above historical averages for the time of year, and the continent has largely replaced Russian pipeline volumes with liquefied natural gas imports and demand reduction. The energy shock, in Vanguard's phrasing, has "evolved broadly in line with our base-case scenario."

German fiscal stimulus provides a structural tailwind

One reason the outlook holds up is Berlin's spending. The German government's fiscal stimulus, centred on military procurement and infrastructure investment, acts as a tailwind that extends through the forecast horizon. The Bundesbank has noted that the special defence fund and the climate and transformation fund together represent a fiscal impulse of roughly 0.5% of GDP per year over the medium term. For an economy that has flirted with recession for much of the past two years, that matters. It also means Germany, traditionally the euro area's growth engine, may finally contribute positively rather than dragging the aggregate down.

Vanguard expects growth to accelerate to 1.3% in 2027 as the headwinds from the energy shock and last year's trade shock fade. That is not a vigorous recovery by historical standards, but it would represent a return to something closer to the euro area's potential growth rate, which the European Commission estimates at around 1.2% to 1.4%.

Inflation dynamics: energy pass-through still feeding through

The inflation picture is more mixed. Vanguard sees headline inflation ending 2026 at 3.3%, well above the ECB's 2% target, because high energy costs continue to pass through to consumer prices with a lag. Core inflation, which strips out volatile energy, food, alcohol and tobacco, is forecast to moderate to 2.2% by year-end. The gap between headline and core reflects the mechanical effect of earlier energy price spikes working their way through supply chains, a process that is largely arithmetic rather than a sign of broadening price pressures.

Crucially, Vanguard views the risk of de-anchored inflation expectations as low. The ECB's credibility, moderating wage growth, and a labour market that is less tight than during the 2022 surge all argue against a wage-price spiral. There is "limited evidence that the energy shock will generate material or persistent second-round inflation effects," Raithatha writes. That assessment matters because it underpins the case for stopping rate hikes soon.

ECB policy: one insurance hike, then a pivot

Vanguard expects the ECB to follow its June rate increase with one further hike in September, taking the deposit facility rate to 4.0%. Both moves are characterised as "insurance hikes", policy tightening not because inflation is entrenched, but because the central bank wants to be sure it is not. The ECB's own communication has emphasised data dependence and a meeting-by-meeting approach, which leaves the September decision open. But the logic of an insurance hike is that once energy prices stabilise, the need for restrictive policy diminishes quickly.

The forecast then sees two rate cuts in 2027, reversing the last two hikes. That is a faster easing path than some market participants have priced in, and it rests on the assumption that inflation will be convincingly on track for 2% by late 2026. If core inflation proves stickier, services inflation has been persistent across the major economies, the ECB may pause longer before cutting. Vanguard's view is that the conditions for entrenched inflation are absent.

Risks skew to the downside on inflation, upside on growth

The risk assessment is asymmetric. On inflation, risks skew to the downside: if energy prices continue to ease, headline inflation could fall faster than forecast. On growth, the risks are more balanced but with a slight upside tilt from the German fiscal impulse and the possibility that the global manufacturing cycle turns more decisively. The main downside risk remains a further geopolitical escalation that drives energy prices back to 2022 highs, a scenario Vanguard treats as a tail risk rather than a base case.

Labour markets are another watchpoint. Unemployment across the euro area sits at historic lows, but vacancy rates have eased and wage growth, while still above the ECB's comfort zone, has moderated from its peak. The ECB's own wage tracker shows negotiated wage growth slowing in the second quarter. If that trend continues, the case for restrictive policy weakens further.

What this means for 2027 and beyond

The 1.3% growth forecast for 2027 assumes a benign confluence: energy prices stable, fiscal support continuing, global trade recovering, and monetary policy becoming accommodative. That is a lot of moving parts. The German fiscal stimulus is legislated but could be pared back if the constitutional court tightens the debt brake interpretation. The ECB's cutting cycle depends on inflation cooperating. Global trade depends on the US and Chinese economies avoiding sharp slowdowns.

Vanguard's outlook is arguably more optimistic than the consensus on the speed of policy easing, but more cautious on the growth rebound. The International Monetary Fund's July update saw 2027 growth at 1.5%, while the European Commission's spring forecast had 1.4%. The difference largely reflects how quickly each forecaster expects monetary policy to transmit to the real economy. Vanguard's view that two cuts in 2027 will be enough to support a pickup implies a relatively high sensitivity of investment to interest rates, a proposition that will be tested.