The eurozone’s combined budget deficit is forecast by the IMF to widen to 3.3% of GDP in 2026, up from 2.9% in 2025.
Higher energy prices and increased military spending, driven by the Middle East conflict, are the primary causes for the expected increase.
The ECB is holding its benchmark rate at 2%, balancing inflation concerns against the risk of stifling a fragile economic recovery.
Eurozone governments narrowed their combined budget deficit to 2.9% of gross domestic product in 2025, but the International Monetary Fund forecasts it will rebound to 3.3% in 2026 as the region confronts higher energy prices and increased military spending linked to the Middle East conflict.
“Governments that try to cushion every shock for every household risk undermining fiscal sustainability at their peril,” European Central Bank President Christine Lagarde said in a speech Monday, cautioning against broad-based subsidies.
The gap between spending and revenue for the 20 eurozone members fell to 2.9% of GDP last year from 3% in 2024, a significant improvement from the 7% peak in 2020, the European Union’s statistics agency Eurostat reported Wednesday. Accumulated government debt rose slightly to 87.8% of GDP. However, the IMF’s projection for a deficit rebound to 3.3% this year highlights new fiscal strains.
The widening deficit signals renewed fiscal pressure on member states, which could elevate government borrowing costs and create headwinds for the euro. The conflict's duration remains a critical variable, with a prolonged disruption of energy supplies through the Strait of Hormuz posing a significant risk to the bloc's economic stability and growth prospects.
The primary drivers for the expected deficit increase are twofold: the energy shock stemming from the US-Israeli war on Iran and a concurrent military buildup. The conflict has already pushed eurozone inflation to 2.6% in March, above the ECB's two-percent target, forcing governments to roll out support for households and businesses.
This response echoes the fiscal measures deployed after Russia’s 2022 invasion of Ukraine. The IMF estimates that the broadly distributed support offered then totaled 2.5% of Europe’s GDP. The fund calculates that if current support was targeted only at those most in need, the cost could be limited to 0.9% of GDP in 2026, freeing up fiscal resources. At the same time, nations are increasing military expenditures to reduce reliance on the U.S. in the face of a greater perceived threat from Russia.
The fiscal landscape is not uniform across the currency area. While the French government saw its budget deficit fall to 5.1% of GDP from 5.8% in 2024, its overall debt climbed to 115.6% of GDP, according to Eurostat. The Belgian government’s debt jumped to 107.9% of GDP.
In contrast, some nations showed improvement. Greece’s government, for example, saw its debt-to-GDP ratio decline to 146.1% from 154.2%, though it remains one of the highest in the bloc. According to Eurostat, nine members of the eurozone had debts below the 60% of GDP target, while for five members, debts exceeded annual economic output, underscoring the divergent challenges facing policymakers.
The ECB is now in a difficult position, holding its benchmark deposit rate at two percent. Policymakers are hesitant to raise rates and stifle a lackluster economy, particularly after a survey showed eurozone business activity contracted for the first time in 16 months in April due to the war's impact. ING economist Carsten Brzeski said the ECB is back in "crisis mode." Still, unlike 2022, the conditions for a broad surge in non-energy prices and wages are not in place, giving the central bank what Oddo BHF economist Bruno Cavalier called "the luxury of doing nothing" for the moment.
This article is for informational purposes only and does not constitute investment advice.
