Strong growth, weak inflation
The final quarter of 2025 concluded on a strong note, with GDP growth at 0.3% q/q, exceeding ECB staff projections of 0.2%. The growth surprise was driven by stronger-than-expected performance in Germany, Spain, and Italy, while France grew as anticipated, albeit modestly. Private consumption played a key role in driving Q4 growth, which was broad-based across the eurozone. This supports the ECB's assessment that the economy is in a "good place." However, as 2026 begins, more recent indicators suggest mixed signals for the economy. The composite PMI declined slightly to 51.3 in January from 51.5 thereby still signalling a modest expansion. While the PMIs surprised to the downside, recent months have seen significant volatility. Although, the composite PMI remains stable overall, the downward trend in the service sector warrants close monitoring.
Headline inflation in January fell to 1.7% y/y, below the ECB 2%-target, from 2.0% in December. This was largely driven by energy inflation, which declined sharply to -4.1% y/y from -2.1%, reflecting a significant base effect. Services inflation surprised to the downside, with very low monthly price increases of around 0.1% m/m s.a., This was a slightly dovish signal as elevated services inflation had been a focal point for the ECB. Beyond energy base effects, January's inflation print is affected by country-specific policy measures, such as Germany's VAT cut on restaurants and the Netherlands' VAT hike on accommodation. These factors make it difficult to draw firm conclusions from the January inflation print, but we do read it as a weak print due to services.
For the fifth consecutive meeting, the ECB left its key policy rate unchanged at 2.00%, aligning with expectations. During the press conference, President Lagarde highlighted positive factors such as low unemployment (6.2% in Dec), solid private balance sheets, and increased public spending, which contributed to strong Q4 growth. She downplayed concerns about inflation undershooting and the strengthened euro. Despite headline inflation falling below the ECB's 2% target, there is a clear bias towards holding the deposit rate steady in our view. For details, see ECB Review: Accentuate the positive, 5 February.
The EU and India have finalised a trade agreement 20 years in the making. The deal will eliminate tariffs on over 90% of goods traded between the regions within seven years. The current simple average tariff rate on EU imports is 15%. In November, India accounted for just 1.5% of total euro area exports, far behind the US at 14.2%. While short-term economic changes are unlikely due to limited current exports, the long-term potential is significant. India is one of the world's fastest-growing economies, with a projected growth rate in GDP of around 6.5% y/y until 2030, making it a key emerging G20 economy. A major opportunity lies in India's expanding middle class, and for European automakers. Tariffs on cars will gradually drop from 110% to as low as 10%, while tariffs on car parts will be fully eliminated within five to ten years.
Author
Danske Research Team
Danske Bank A/S
Research is part of Danske Bank Markets and operate as Danske Bank's research department. The department monitors financial markets and economic trends of relevance to Danske Bank Markets and its clients.
