Impact of Middle East Tensions on the Global Economy and Commodity Markets | Chapter 4European Economy: Investment Supports Growth amid Consumption, Export, and Debt

In the first half of 2026, a recovery in economic activity was confirmed in both the euro area and the United Kingdom. However, the composition of the recovery is not uniform. In the euro area, Spain and Italy contributed to growth against the backdrop of a recovery in tourism after the spread of infectious disease, and employment remained resilient. Meanwhile, the pace of household consumption recovery slowed following worsening conditions in the Middle East and higher crude oil prices, while goods exports stagnated because of declining Chinese demand and reduced competitiveness in the automotive industry. In the United Kingdom, growth accelerated as consumption recovered, but weakness in employment and investment remains.

The euro area's negative growth in the January–March 2026 quarter was largely affected by Ireland's real GDP, which fell at an annualized quarter-on-quarter rate of 40.2%. Excluding Ireland, growth was positive at 1.4% in the October–December 2025 quarter and 1.0% in the January–March 2026 quarter; even an estimate adjusted by the European Central Bank for multinational enterprise transactions shows quarter-on-quarter growth of 0.2% in the January–March 2026 quarter. This resulted from intra-company transactions by multinational enterprises, including pharmaceutical companies, with their headquarters in Europe and the United States, which caused statistical fluctuations; it does not mean that the entire domestic economy within the region deteriorated on the same scale.

Unless otherwise specified, the euro area is treated as comprising 21 countries because Bulgaria officially adopted the euro in January 2026. In household consumption, services accounted for 55.7% of the composition in 2025, followed by non-durable consumer goods at 28.6%, durable consumer goods at 8.1%, and semi-durable consumer goods at 7.6%. In the labor market, the unemployment rate was 6.3%, the labor force participation rate was 75.7%, and the vacancy rate was 2.2%, still above the five-year average before the spread of infectious disease.

The impact on households appears as pressure on real purchasing power through higher energy prices and increased precautionary saving caused by uncertainty about the future. In the euro area, real household disposable income in 2025 reached 108.8 relative to 2019, while the household saving rate was 14.4%, making it difficult for higher income to translate into consumption. In the United Kingdom, the household saving rate was 9.9% in 2025, above the 5.7% average for 2016–2019. Deteriorating consumer sentiment is restraining purchases of high-priced goods and could weaken the economic recovery through domestic demand.

Businesses and regions are simultaneously experiencing demand creation from public investment and decarbonization support, as well as polarization caused by international competition and insufficient capital. The EU's Industrial Accelerator Act proposal covers steel, cement, aluminum, automobiles, and net-zero technologies, promoting the use of EU-produced and low-carbon products through public procurement and public support. It sets a target of raising manufacturing's share of GDP from 14.3% in 2024 to 20% in 2035, and anticipates more than 600 million euros in added value for steel and aluminum, up to approximately 10.5 billion euros for the automotive industry network, 85,000 jobs in batteries, and 58,000 jobs related to solar power.

In policy management, it is becoming more difficult to balance growth support with fiscal discipline. The EU's Stability and Growth Pact sets limits of 3% of GDP for the fiscal deficit and 60% for public debt, but exceptional room for defense spending and energy measures is encouraging expenditure growth. In Germany, general government finances are projected to show a deficit of 4.1% in 2027 and public debt of 68.0% as investment and defense spending expand. In France, the fiscal deficit reached 5.1% and public debt 115.6% in 2025, and they are projected to reach 5.7% and 120.2%, respectively, in 2027.

Investment in the euro area is supported by the RRF, the Rearm Europe Plan, and Germany's fiscal expansion. The RRF covers six areas: the green transition, digitalization, sustainable growth, social cohesion, institutional reform, and education and skills development, with at least 37% of allocated funds directed to the green transition and 20% to digitalization. RRF grant allocations are determined using population, GDP per capita, and past unemployment rates as 70% of the criteria, and past GDP declines and other shocks as 30%. Italy and Spain received large allocations because their tourism industries suffered significant damage, and their increases in capital investment are also notable. Because the investment implementation deadline and the funding payment deadline are concentrated in 2026, an increase before the deadlines and a decline afterward are expected.

In a March 2025 amendment to its Basic Law, Germany exempted the special fund for infrastructure and climate action and defense spending exceeding 1% of nominal GDP from the debt brake. The special fund can borrow up to 500 billion euros from 2025 through 2036, allocating 100 billion euros each to the states and local governments and to the Climate and Transformation Fund. Actual investment in 2025 was approximately 86.8 billion euros, up 17% from the previous year, while the 2026 investment budget is approximately 128.7 billion euros. An investment incentive tax regime was introduced for private investment, but investment sentiment deteriorated in early summer 2026 against the backdrop of conditions in the Middle East and other factors.

In AI, Europe is relatively weak both in large cloud companies that generate demand and in semiconductor supply, and more than 80% of the EU's digital products, services, and infrastructure are considered dependent on sources outside the region. In 2025, the United States accounted for 72% of global venture capital investment in AI and data companies, compared with 7% for the 27 EU countries, leaving EU investment at approximately one-tenth of US investment. Europe has companies such as Mistral AI, Aleph Alpha, Celonis, and ASML, but the overall ecosystem, including capital markets, remains limited in scale. Through the AI Continent Action Plan in April 2025, Apply AI and AI in Science, RAISE in October 2025, and the European Technology Sovereignty Package, Chips Act 2.0, and Cloud and AI Development Act proposal in June 2026, the European Commission is seeking to strengthen regional capabilities in research, adoption, computing resources, semiconductors, and data centers.

In euro area exports, services exports accounted for 16.7% of GDP in 2025, while goods exports accounted for 31.9%. Goods exports have been broadly flat since 2022, weighed down by declining Chinese demand, reduced automotive competitiveness, and high energy costs. Export destinations were the United States at 17.1%, the United Kingdom at 9.9%, Poland at 7.7%, Switzerland at 7.0%, and China at 6.0%. To reduce dependence on the United States, the EU concluded FTA negotiations with India in January 2026, applied an interim agreement with Mercosur in May, and signed an agreement modernizing its pact with Mexico. Between the United States and the EU, the elimination of EU tariffs on US industrial products and preferential market access for US agricultural and fishery products took effect on July 1, 2026.

In the United Kingdom, the recovery in consumption during the January–March 2026 quarter boosted economic activity, while employment fell by 52,600 from the previous month in April 2026, the vacancy rate was 2.4%, and the unemployment rate was 4.9%, indicating looser labor supply and demand. The EV purchase subsidy scheme launched in July 2025 provides up to 3,750 pounds for new EVs priced at 37,000 pounds or less, increasing PHEV and BEV sales by more than 30% year on year. Goods exports were flat at 12.7% of GDP, while services exports were 18.0% of GDP and continued to recover against the backdrop of tourism and business services.

Overall, the euro area may continue a gradual short-term recovery supported by government consumption, public investment, and contributions from growth in Spain and Italy, but household consumption, goods exports, investment after the end of the RRF, and fiscal space require attention. Domestic demand is also expected to continue recovering in the United Kingdom, but high interest rates and downside risks to employment remain concerns. At present, the impact of conditions in the Middle East on Europe as a whole is more limited than during Russia's invasion of Ukraine in 2022.