Economic, financial and monetary developments

Overview

At its meeting on 11 September 2025, the Governing Council decided to keep the three key ECB interest rates unchanged. Inflation is currently at around the 2% medium-term target and the Governing Council’s assessment of the inflation outlook is broadly unchanged.

The September 2025 ECB staff macroeconomic projections for the euro area present a picture of inflation similar to that projected in June. They see headline inflation averaging 2.1% in 2025, 1.7% in 2026 and 1.9% in 2027. For inflation excluding energy and food, they expect an average of 2.4% in 2025, 1.9% in 2026 and 1.8% in 2027. The economy is projected to grow by 1.2% in 2025, revised up from the 0.9% expected in June. The growth projection for 2026 is now slightly lower, at 1.0%, while the projection for 2027 is unchanged at 1.3%.

The Governing Council is determined to ensure that inflation stabilises at its 2% target in the medium term. It will follow a data-dependent and meeting-by-meeting approach to determining the appropriate monetary policy stance. In particular, the Governing Council’s interest rate decisions will be based on its assessment of the inflation outlook and the risks surrounding it, in light of the incoming economic and financial data, as well as the dynamics of underlying inflation and the strength of monetary policy transmission. The Governing Council is not pre-committing to a particular rate path.

Economic activity

The economy grew by 0.7% in cumulative terms over the first half of 2025, on account of the resilience in domestic demand. The quarterly pattern showed stronger growth in the first quarter and weaker growth in the second quarter, partly reflecting an initial frontloading of international trade ahead of expected tariff increases and then a reversal of that effect.

Survey indicators suggest that both manufacturing and services continue to grow, signalling some positive underlying momentum in the economy. Even if demand for labour is softening, the labour market remains a source of strength, with the unemployment rate at 6.2% in July 2025. Over time, this should boost consumer spending, especially if, as foreseen in the September 2025 projections, people save less of their income. Consumer spending and investment should benefit from the Governing Council’s past interest rate cuts feeding through to financing conditions. Investment should also be underpinned by substantial government spending on infrastructure and defence.

Trade tariffs and related uncertainty contributed to strong fluctuations in economic activity during the first half of 2025, with frontloading of activity, especially in Ireland. The unwinding of these factors in the second half of the year is expected to entail further volatility, blurring signals of the underlying momentum of the euro area economy. In fact, looking through the volatility caused by the fluctuations in Irish data, economic growth in the rest of the euro area was more stable, and it is expected to remain so in the second half of the year. Although the new US-EU trade agreement implies higher tariffs on euro area exports to the United States, it has helped to reduce trade policy uncertainty. The overall impact of the change in the global policy environment will only become clear over time. Later in the horizon economic growth in the euro area is projected to strengthen, supported by several factors. Rising real wages and employment, together with new government spending on infrastructure and defence, mainly in Germany, should bolster euro area domestic demand. Furthermore, less restrictive financing conditions – mainly reflecting recent monetary policy decisions – and a rebound in foreign demand in 2027 are also seen to support the growth outlook.

Annual average real GDP growth is projected to be 1.2% in 2025, 1.0% in 2026 and 1.3% in 2027. Compared with the June 2025 projections, the outlook for GDP growth has been revised up by 0.3 percentage points for 2025, reflecting better than expected incoming data and a carry-over effect from revisions to historical data. As not all of the data surprises relate to stronger than previously assumed frontloading of activity, they are only seen to be partly offset in the second half of the year. The appreciation of the euro and weaker foreign demand (in part related to somewhat higher tariffs than assumed in the June projections) have resulted in a 0.1 percentage point downward revision for 2026. The projection for 2027 remains unchanged.

The Governing Council considers it crucial to urgently strengthen the euro area and its economy in the present geopolitical environment. Fiscal and structural policies should make the economy more productive, competitive and resilient. One year on from the release of Mario Draghi’s report on the future of European competitiveness, it remains essential to follow up on its recommendations with further concrete action and to accelerate implementation, in line with the European Commission’s roadmap. Governments should prioritise growth-enhancing structural reforms and strategic investment, while ensuring sustainable public finances. It is critical to complete the savings and investments union and the banking union, to an ambitious timetable, and to rapidly establish the legislative framework for the potential introduction of a digital euro.

Inflation

Annual inflation remains close to the Governing Council’s target, edging up to 2.1% in August 2025 from 2.0% in July. Energy price inflation was -1.9%, after -2.4% in July, while food price inflation declined to 3.2% from 3.3%. Inflation excluding energy and food stayed constant at 2.3%. Services inflation edged down to 3.1%, from 3.2% in July, while goods inflation was unchanged at 0.8%.

Indicators of underlying inflation remain consistent with the Governing Council’s 2% medium-term target. Year-on-year growth in compensation per employee was 3.9% in the second quarter, down from 4.0% in the previous quarter and 4.8% in the second quarter of 2024. Forward-looking indicators, including the ECB’s wage tracker and surveys on wage expectations, suggest that wage growth will moderate further. Along with productivity gains, this will help keep a lid on domestic price pressures, even as profits recover from low levels.

The new ECB staff projections present a picture of inflation similar to that projected in June. Headline inflation, as measured by the Harmonised Index of Consumer Prices (HICP), is projected to move sideways, at around 2%, for the rest of 2025, and then to drop to an average of 1.7% in 2026 before recovering to 1.9% in 2027. The drop in 2026 reflects a further gradual easing in the non-energy components, while energy inflation is expected to remain volatile, but to rise over the projection horizon, in part because of the start of the EU Emissions Trading System 2 in 2027. Food inflation is expected to remain elevated initially, as lagged effects from past price increases in international food commodities feed through, but to moderate to rates somewhat above 2% in 2026 and 2027.

HICP inflation excluding energy and food is expected to fall from 2.4% in 2025 to 1.9% in 2026 and 1.8% in 2027, as wage pressures recede and services inflation moderates, while the appreciation of the euro feeds through the pricing chain and curbs goods inflation. Lower wage growth, as past real wage losses have been recouped, coupled with a recovery in productivity growth, is expected to lead to significantly slower unit labour cost growth.

Compared with the June 2025 projections, the outlook for headline HICP inflation has been revised up by 0.1 percentage points for both 2025 and 2026. This is on account of higher energy commodity price outcomes and assumptions, as well as lagged effects from higher international food commodity prices, which more than offset the effects of the appreciation of the euro. For 2027, the lagged effects of the appreciation of the euro are seen to predominate, resulting in a 0.1 percentage point downward revision.

Most measures of longer-term inflation expectations continue to stand at around 2%, supporting the stabilisation of inflation around the Governing Council’s target.

Risk assessment

Risks to economic growth have become more balanced. While recent trade agreements have reduced uncertainty, a renewed worsening of trade relations could further dampen exports and drag down investment and consumption. A deterioration in financial market sentiment could lead to tighter financing conditions, greater risk aversion and weaker growth. Geopolitical tensions, such as Russia’s unjustified war against Ukraine and the tragic conflict in the Middle East, remain a major source of uncertainty. By contrast, higher than expected defence and infrastructure spending, together with productivity-enhancing reforms, would add to growth. An improvement in business confidence could stimulate private investment. Sentiment could also be lifted and activity spurred if geopolitical tensions diminished, or if the remaining trade disputes were resolved faster than expected.

The outlook for inflation remains more uncertain than usual, as a result of the still volatile global trade policy environment. A stronger euro could bring inflation down further than expected. Moreover, inflation could turn out to be lower if higher tariffs lead to lower demand for euro area exports and induce countries with overcapacity to further increase their exports to the euro area. Trade tensions could lead to greater volatility and risk aversion in financial markets, which would weigh on domestic demand and would thereby also lower inflation. By contrast, inflation could turn out to be higher if a fragmentation of global supply chains pushed up import prices and added to capacity constraints in the domestic economy. A boost in defence and infrastructure spending could also raise inflation over the medium term. Extreme weather events, and the unfolding climate crisis more broadly, could drive up food prices by more than expected.

Financial and monetary conditions

Since the Governing Council’s monetary policy meeting in July 2025 short-term market rates have increased, while longer-term rates have remained broadly unchanged. However, the Governing Council’s past interest rate cuts continued to lower corporate borrowing costs in July. The average interest rate on new loans to firms moved down to 3.5% in July, from 3.6% in June. The cost of issuing market-based debt was unchanged, at 3.5%. Loans to firms grew by 2.8%, slightly more strongly than in June, while the growth of corporate bond issuance rose to 4.1% from 3.4%. The average interest rate on new mortgages was again unchanged at 3.3% in July, while growth in mortgage lending picked up to 2.4%, from 2.2%.

Monetary policy decisions

The interest rates on the deposit facility, the main refinancing operations and the marginal lending facility were kept unchanged at 2.00%, 2.15% and 2.40% respectively.

The asset purchase programme and pandemic emergency purchase programme portfolios are declining at a measured and predictable pace, as the Eurosystem no longer reinvests the principal payments from maturing securities.

Conclusion

At its meeting on 11 September 2025, the Governing Council decided to keep the three key ECB interest rates unchanged. The Governing Council is determined to ensure that inflation stabilises at its 2% target in the medium term. It will follow a data-dependent and meeting-by-meeting approach to determining the appropriate monetary policy stance. The Governing Council’s interest rate decisions will be based on its assessment of the inflation outlook and the risks surrounding it, in light of the incoming economic and financial data, as well as the dynamics of underlying inflation and the strength of monetary policy transmission. The Governing Council is not pre-committing to a particular rate path.

In any case, the Governing Council stands ready to adjust all of its instruments within its mandate to ensure that inflation stabilises sustainably at its medium-term target and to preserve the smooth functioning of monetary policy transmission.

1 External environment

Global economic activity is expected to remain steady but subdued in the near term following stronger than expected growth in the first half of 2025 that is unlikely to be sustained. Global import growth is expected to decline, as the frontloading-related surge observed earlier in the year in anticipation of tariff increases is expected to fade away. Higher US tariffs and still elevated uncertainty are reshaping global trade flows and posing a risk to logistics, although global supply chain pressures appear to be contained so far. Disinflation seems to have paused in some advanced economies, with core goods inflation showing renewed momentum, particularly in the United States. Against this background, the September 2025 ECB staff macroeconomic projections for the euro area foresee a weaker global growth outlook going forward. Nevertheless, the slowdown in global activity is expected to be less steep than predicted in the June 2025 Eurosystem staff macroeconomic projections, reflecting positive data surprises, while fiscal expansion in the United States, receding trade policy uncertainty and easing global financial conditions are expected to cushion the impact of newly announced tariffs. Globally, headline consumer price index (CPI) inflation is expected to moderate over the projection horizon, notwithstanding the projected pick-up in headline CPI inflation in the United States in 2026 on account of tariffs, fiscal expansion and the depreciation of the US dollar.

Global growth (excluding the euro area) is expected to remain subdued but steady over the near term. Global GDP grew by 0.9% quarter-on-quarter in the second quarter, up from 0.7% in the first quarter. While activity surprised on the upside in major economies, such as the United States and China, it reflected large swings in net exports and inventories rather than underlying strength in the global economy. These frontloading-related distortions – due to precautionary behaviour by firms and consumers ahead of tariffs – are expected to fade gradually, meaning their temporary boost to activity is unlikely to be sustained into the second half of the year. Recent data support this assessment, with the ECB staff nowcasting model pointing to weaker real GDP growth in the third quarter. The global composite output Purchasing Managers’ Index (PMI) improved in August, supported by the manufacturing sector rebounding out of contraction territory to 51.6, while services output remained broadly stable at 54.0 (Chart 1).

Chart 1

Global output PMI (excluding the euro area)

(diffusion indices)

The global growth outlook is expected to weaken, although less sharply than envisaged in the June 2025 Eurosystem staff macroeconomic projections. Global growth is projected to slow over the projection horizon, drifting below its pre-pandemic average (3.6%), as tariffs and policy uncertainty weigh on consumption and erode investment prospects. According to the September 2025 ECB staff macroeconomic projections, global real GDP is projected to grow at 3.3% in 2025 (down from 3.6% in 2024), with growth decreasing further to 3.1% in 2026 before recovering modestly to 3.3% in 2027.^[1] While real GDP growth surprised on the upside in the second quarter of 2025 across major economies (e.g. in the United States, China and the United Kingdom), recent economic data point to a slowdown in activity in the second half of the year, notably amid weakening labour demand in the United States and decelerating retail sales and investment in China. Risks surrounding the global outlook remain tilted to the downside, as a re-escalation of the trade war could dampen activity. In addition, fiscal sustainability concerns in large advanced economies may trigger excessive financial market volatility and negative spillovers globally. On the upside, successful trade negotiations – particularly between the United States and China – could avert a major escalation of tariffs and help reduce global policy uncertainty.

Global trade dynamics are expected to weaken amid higher tariffs and persistent trade policy uncertainty, the apparent resilience in the first half of 2025 notwithstanding. Global trade slowed in the second quarter and is expected to soften further, offsetting the surge observed in the first quarter. The ECB trade tracker, which is based on incoming high-frequency indicators, points to subdued trade dynamics in the third quarter with the momentum still negative in July and August. According to the September 2025 ECB staff macroeconomic projections, global import growth is expected to decline significantly from 4.2% in 2024 to 2.8% in 2025 and 1.5% in 2026, before recovering to 3.1% in 2027. The sharp slowdown going forward reflects the unwinding of earlier frontloading, the impact of tariffs and elevated trade policy uncertainty, which dampens investment, leading to a less trade-intensive composition of global demand. As US imports are expected to rebound after contracting in 2026, global trade is expected to recover somewhat in 2027, although at a slower pace than global real GDP growth. Compared with the June 2025 Eurosystem staff macroeconomic projections, global import growth has been revised down, largely due to newly implemented tariffs compounded by a downward reassessment of the import intensity of growth in China. Finally, while tariffs can pose challenges for logistics, broad-based global supply chain pressures are currently contained. Some signs of strain are visible in sectors such as aluminium, steel and textiles, but these remain far more muted than the disruptions observed during the post-pandemic period.

Headline inflation across Organisation for Economic Co-operation and Development (OECD) members remained above 2% and core inflation increased slightly in July. Excluding Türkiye, annual CPI inflation across the OECD remained stable at 2.7% in July (Chart 2). While both energy and food price inflation receded in July (by 0.6 percentage points compared with June to 0.2% for energy, and by 0.1 percentage points to 3.4% for food), core inflation increased slightly to 3.1%, up from 3.0% in both May and June. Looking forward, PMI surveys on input and output prices are signalling a slight acceleration over the near term in advanced economies, mostly driven by developments in the United States.

Chart 2

OECD CPI inflation

(year-on-year percentage changes, percentage point contributions)

Annual headline CPI inflation across a broad group of advanced economies and emerging markets is projected to moderate further over the projection horizon, notwithstanding inflationary pressures in the United States. Compared with the June 2025 Eurosystem staff macroeconomic projections, inflation has been revised downwards slightly for 2025 across large economies, such as the United States, China and India, owing to lower than expected data outturns in the second quarter. By contrast, inflation projections across a broad group of advanced economies and emerging markets have been revised upwards for 2026, as higher tariffs and fiscal expansion are projected to intensify inflationary pressures in the United States. This also partly reflects a delayed pass-through of tariffs, since duties primarily affected goods located upstream in supply chains and earlier frontloading allowed firms to build up inventories of tariffed goods. Globally, the upward revision of US headline CPI inflation in 2026 is partly offset by downward revisions across emerging market economies, reflecting in particular the weaker-than-expected inflation momentum in China and India. According to the September 2025 ECB staff macroeconomic projections, a global composite of headline CPI inflation across advanced and emerging economies is projected to moderate from 4.0% in 2024 to 3.2% in 2025, before easing further to 2.9% in 2026 and 2.5% in 2027.^[2]

Oil prices increased owing to geopolitical tensions in the Middle East, while gas prices declined following peace talks between Russia and Ukraine. Oil prices rose by 1.4% over the review period (5 June to 10 September), driven by a sharp increase following Israeli and US military strikes on Iran in mid-June. The initial rise was, however, partly reversed, as the risk of further escalation subsided. Additional downward pressure came from two successive OPEC+ decisions to raise output, completing the unwinding of the 2.2 million barrels per day production cuts introduced by the cartel in November 2023 at a pace that has surprised markets. European gas prices initially came under pressure from abundant liquified natural gas supply and subdued domestic demand, which kept gas storage on track to reach adequate levels ahead of next winter. Prices fell further following the resumption of peace talks between Russia and Ukraine, reaching their lowest level in more than a year and declining by 14.6% over the review period. Metal prices increased by 1%, led by copper as markets anticipated the implementation of US tariffs on that commodity. However, initial gains were later partially reversed after the United States unexpectedly excluded refined copper from the measures, restricting its tariffs to semi-finished products. Food prices declined by 7.7%, mainly due to a drop in cocoa prices, which experienced volatile movements over the period owing to weather-related factors.

In the United States, core GDP components (private consumption and investment) decelerated in the first half of 2025, while inflation picked up partly due to tariffs. While real GDP growth rebounded to 0.7% quarter-on-quarter in the second quarter (after a 0.1% contraction in GDP in the previous quarter), it was driven by a strong net trade contribution and falling inventories largely offsetting earlier tariff-related trade dynamics. By contrast, real final sales to private domestic purchasers (excluding government expenditure, net trade and inventories) continued to decelerate in the second quarter. Activity is expected to moderate in the second half of the year as tariffs, weak confidence and slowing real disposable income growth weigh on consumption and investment. This is consistent with signs of weakening labour demand as non-farm payrolls surprised on the downside in July and August, with sizeable downward revisions for previous months as well. On the nominal side, headline personal consumption expenditure (PCE) inflation remained unchanged at 2.6% in July, while core PCE inflation increased to 2.8% (up 0.1 percentage points compared with the previous month) amid signs that tariffs are starting to feed through to core goods prices, especially in categories closely linked to tariffed imports (e.g. household furnishings, recreation goods). While US producers and retailers may currently be absorbing most of the tariff increases – with high corporate profits and pre-emptive inventory accumulation acting as temporary buffers – the pass-through of higher tariffs to consumer prices is expected to increase over time. Against this background, and with inflationary pressures triggered by US fiscal expansion and US dollar depreciation, the September 2025 ECB staff macroeconomic projections foresee headline CPI inflation rising to 3.3% in 2026, markedly up from 2.8% in 2025. In his Jackson Hole speech on 22 August, Federal Reserve Chair Jerome Powell acknowledged that “downside risks to employment are rising” and noted that the balance of risks may warrant policy adjustment.

In China, export growth remained resilient, while domestic demand weakened further. The economy stayed broadly robust in the first half of 2025 amid strong export growth, but momentum slowed in the third quarter as July data on retail sales, industrial production and fixed asset investment all surprised on the downside. Beyond policy-supported sectors, domestic demand remains weak with a persistently soft housing market and subdued consumer spending outside of subsidised goods. Exports, however, continued to perform strongly in July and should remain resilient in the near term, supported by the extension of the US-China tariff pause to November. Inflationary pressures remained muted in July, with consumer prices flat at 0.0% year-on-year (down 0.1 percentage points from the previous month) and producer prices deeply in negative territory at -3.6% year-on-year (unchanged from the previous month). In response, authorities stepped up the “anti-involution” campaign in mid-2025, introducing stronger measures to curb predatory price competition and excess capacity, especially in green sectors, such as solar, batteries and electric vehicles. However, it remains unclear whether these initiatives will be sufficient to materially ease deflationary pressures going forward.

In the United Kingdom, real GDP growth moderated in the second quarter while inflation continued to increase. Output grew by 0.3% quarter-on-quarter in the second quarter, surprising on the upside but slowing from the first quarter when activity had been strongly supported by the frontloading of demand ahead of tariffs and tax measures. Looking ahead, activity is expected to remain moderate in the near term amid global headwinds and uncertainty surrounding the Autumn Budget, with anticipated tax increases likely to weigh on confidence. Annual headline inflation rose further to 3.8% in July (up 0.2 percentage points from the previous month), driven by persistent services inflation, with transport – especially volatile air fares – being the largest contributor. Inflation is projected to peak in the third quarter on account of regulated energy price changes, before gradually easing towards target. Against this backdrop, the Bank of England lowered its Bank Rate by 25 basis points to 4% in August.

2 Economic activity

Tariffs and related uncertainty contributed to strong fluctuations in economic activity during the first half of 2025, with frontloading of activity, especially in Ireland. Following the strong first-quarter outcome of 0.6%, real GDP growth slowed in the second quarter, edging up by 0.1%, quarter on quarter. Employment rose by 0.1% in the second quarter, at the same rate as GDP. From a sectoral perspective, the services sector was the main contributor to growth in the second quarter, growing at a similar pace to the first quarter. Meanwhile, growth in industry slowed vis-à-vis the first quarter as frontloading effects unwound, tariffs increased and geopolitical and trade policy uncertainty remained elevated. Survey data are sending somewhat mixed signals, but overall point to a continued modest expansion in activity in the third quarter of 2025. While uncertainty declined after the US-EU trade deal, it remains elevated by historical standards; this, combined with higher tariffs, the appreciation of the euro and increased global competition, is weighing on the short-term outlook, especially for the manufacturing sector. At the same time, growth in services is expected to remain the main driver of growth as consumers signal continued spending on services. While the labour market has softened over recent months, it remains a source of strength. Looking ahead, increased consumer spending, especially if people save less of their income, together with new government spending on infrastructure and defence, should bolster domestic demand in the euro area. Furthermore, less restrictive financing conditions – mainly reflecting recent monetary policy decisions – should also support a gradual recovery.

This outlook is reflected in the baseline scenario of the September 2025 ECB staff macroeconomic projections for the euro area, which foresee annual real GDP growth of 1.2% in 2025, 1.0% in 2026 and 1.3% in 2027. Compared with the June 2025 Eurosystem staff macroeconomic projections, the outlook for GDP growth has been revised up for 2025 by 0.3 percentage points, reflecting better than expected incoming data and a carry-over effect from revisions to historical data. In addition, the appreciation of the euro and weaker foreign demand have led to a small downward revision of 0.1 percentage points to GDP growth for 2026, while the outlook for 2027 remained unchanged.

Real GDP growth slowed in the second quarter of 2025 amid persistent geopolitical and trade policy uncertainty (Chart 3). Following the strong first-quarter outcome, which was partly driven by firms frontloading exports ahead of the expected tariff hikes, GDP growth slowed in the second quarter, edging up by 0.1%, quarter on quarter, reflecting the unwinding of these effects (see Box 3 on how frontloading and uncertainty shaped recent developments). Despite higher volatility in the past two quarters (largely related to the impact from Irish data), the latest outcome marks the seventh consecutive quarter of positive growth in the euro area. The moderate expansion in euro area real GDP in the second quarter was supported by private and public consumption as well as changes in inventories. At the same time, exports and investment contracted – the latter on the back of a relatively large drop in non-construction investment, driven by developments in Irish intellectual property products. As imports displayed zero growth, net trade contributed negatively to growth in the second quarter. From a sectoral perspective, the services sector was the main contributor to growth, expanding at a similar pace to the first quarter. Meanwhile, growth in industry slowed vis-à-vis the first quarter, reflecting the unwinding of frontloading effects and tariff increases. Furthermore, value added in construction fell, amply offsetting the strong rise seen in the first quarter.

Chart 3

Euro area real GDP and its components

(quarter-on-quarter percentage changes; percentage point contributions)

Survey data are sending somewhat mixed signals, but overall point to a continued modest expansion in activity in the third quarter of 2025. The still elevated level of uncertainty, higher tariffs and the appreciation of the euro are weighing on the short-term outlook. The composite output Purchasing Managers’ Index (PMI) rose to 51.0 on average in July and August (from 50.4 in the second quarter), indicating slow growth at around the same rate as in the second quarter. While growth in services is assessed to have slowed, it is still expected to be the main driver of growth, chiefly reflecting its larger size compared with the industrial sector. Meanwhile, activity in the manufacturing sector, which was more dynamic at the beginning of the year owing to the frontloading of exports in advance of higher tariffs, is expected to be more muted in the near term – although the latest readings show some improvement (Chart 4). The PMI for new orders portrays a similar picture, with overall slow dynamics. However, this indicator, which is more forward looking by nature, shows a somewhat more subdued improvement going into the fourth quarter of the year.

Chart 4

PMI indicators across sectors of the economy

a) Manufacturing	b) Services
(diffusion indices)	(diffusion indices)

Employment increased by 0.1% in the second quarter of 2025. After rising by 0.2% in the first quarter of 2025, employment growth slowed in the second quarter of the year, standing at 0.1% (Chart 5). This expansion masks diverging trends across the euro area. Among the largest euro area economies, employment growth was mainly driven by Spain while it was largely unchanged or slightly negative in Germany, France and Italy. At the same time, the euro area unemployment rate fell to 6.2% in July, remaining broadly stable at this level since mid-2024. Labour demand declined further, with the job vacancy rate falling to 2.3% in the second quarter, the same level seen in the fourth quarter of 2019.

Chart 5

Euro area employment, PMI assessment of employment and unemployment rate

(left-hand scale: quarter-on-quarter percentage changes, diffusion index; right-hand scale: percentages of the labour force)

Short-term labour market indicators point to modest employment growth in the third quarter. The monthly composite PMI employment indicator increased from 50.5 in July to 50.8 in August, suggesting modest employment growth in the third quarter. The PMI employment indicator for services rose from 50.9 in July to 51.2 in August, while the PMI employment indicator for manufacturing edged down from 49.5 to 49.4.

Private consumption growth moderated in the second quarter of 2025, with survey data pointing to some improvement in spending momentum in the third quarter. Private consumption expanded by 0.1%, quarter on quarter, in the second quarter of 2025 (Chart 6, panel a), after increasing by 0.3% in the first quarter of the year. Household spending on services continued to increase, but goods consumption stagnated, as spending on non-durable goods dropped. Incoming data point to improving momentum in household spending growth in the near term, with sectoral differences persisting. While the European Commission’s consumer confidence indicator remains subdued following a downtick in August, its average level for July and August is higher than in the second quarter. Retail trade fell in July. However, the European Commission’s indicators of business expectations for demand in retail trade and in consumption-weighted services have improved notably since the second quarter (Chart 6, panel a), as activity in consumer services recovered (see Box 3). Consistent with the improvement in consumer expectations for major purchases in the next 12 months seen in July and August, the ECB’s latest Consumer Expectations Survey also indicates that expectations for holiday-related purchases remain strong. Looking ahead, consumption growth should continue to benefit from past purchasing power gains, amid more favourable financing conditions and a notable easing in households’ uncertainty about their financial situation after the peak in late 2022 (Chart 6, panel b). However, despite the improvement in August, the still elevated broader economic policy uncertainty in relation to global developments, particularly the recent trade tensions, is likely to continue to weigh on consumption growth as households adjust their spending habits by reducing overall spending or switching away from US products (see Box 2).

Chart 6

Household consumption and confidence, business expectations; disposable income and uncertainty

a) Consumer spending and confidence, business expectations	b) Disposable income and uncertainty
(quarter-on-quarter percentage changes; standardised percentage balances)	(year-on-year percentage changes; standardised percentage balances)

Business investment grew robustly in the second quarter of 2025 but is expected to slow in the second half of the year. Following growth of 0.7%, quarter on quarter, in both the first and the second quarter of 2025, euro area non-construction investment (excluding Irish intangibles) is expected to be muted in the coming quarters. Capital goods surveys available up to August are somewhat mixed, with PMI output moving further above 50, yet the European Commission’s sentiment index points to weak activity. While domestic demand is supportive, other drivers of investment confirm the short-term weakness. For instance, uncertainty has remained elevated despite declining somewhat after the US-EU trade deal at the end of July and the non-financial corporate gross operating surplus rose modestly in the first quarter after seeing negative rates last year. In addition to higher tariffs, earnings calls reveal some possible adverse impact of the euro’s appreciation on firms’ profits. These factors could dampen investment depending on how firms hedge against currency risk, diversify activity and adjust their margins. In this context, euro area bankruptcies rose further in the second quarter of 2025, standing about 25% above their 2019 level. This reflects both a necessary market adjustment in a period of structural change – as business registrations also grew to levels considerably above pre-pandemic levels – and weaker economic conditions. Beyond the short term, higher demand and spillovers from rising defence spending are seen to spur investment.

Chart 7

Real investment dynamics and survey data

a) Business investment	b) Housing investment
(quarter-on-quarter percentage changes; percentage balances and diffusion index)	(quarter-on-quarter percentage changes; percentage balances and diffusion index)

Housing investment declined slightly in the second quarter of 2025. Housing investment contracted by 0.1%, quarter on quarter, in the second quarter of 2025, following an expansion of 0.5% in the first quarter. Meanwhile, building construction production and specialised construction activities grew by 1.3% on average, compared with an increase of 0.6% in the first quarter. Looking ahead, survey-based activity indicators are presenting mixed signals about the short-term outlook for housing investment. The European Commission’s trend indicator for building construction output and specialised construction activities edged down slightly on average in July and August, whereas the PMI for residential construction output registered a notable improvement (Chart 7, panel b). Although both indicators remained in negative growth territory, housing investment is expected to recover moderately in the near term. This outlook is supported by a continued rise in building permits for residential buildings, which increased by 1.1% on average in April and May compared with their first-quarter average, following gains in the previous two quarters. Even though permits are still at relatively low levels, the sustained upward trend signals strengthening demand for new residential buildings, which is expected to underpin the momentum of housing investment going forward.

The surge in euro area exports stemming from frontloading was partly reversed in the second quarter of 2025 and exports have likely been subdued over the summer. Exports of goods and services declined by 0.5% in the second quarter of 2025. Similar to the increase in the first quarter, about half of the fall in goods exports was related to pharmaceutical products, mainly from Ireland. Survey indicators point to subdued exports over the summer. While the US-EU agreement has reduced some of the trade policy uncertainty by setting a ceiling on the US import tariff at 15% for most EU goods exports, the appreciation of the euro will weigh on exports further ahead. On the imports side, volumes of goods and services remained anaemic overall in the second quarter of 2025 (+0.0%), with rising imports from the United States and China offsetting weaker imports from the rest of the world.

Compared with the June 2025 Eurosystem staff macroeconomic projections, the outlook for GDP growth has been revised up for 2025. This partly reflects better than expected incoming data. At the same time, the growth outlook for 2026 has been revised down slightly owing to the decline in competitiveness stemming from the appreciation of the euro and weaker foreign demand. Annual average real GDP growth is now expected to be 1.2% in 2025, 1.0% in 2026 and 1.3% in 2027. Tariffs and related uncertainty contributed to fluctuations in economic activity during the first half of the year and are expected to limit growth in the short term. However, as exporters adapt to the new US-EU trade agreement and trade policy uncertainty lessens, growth is likely to recover. Looking ahead, rising real wages and employment as well as new government spending on infrastructure and defence should bolster euro area domestic demand. Less restrictive financing conditions – mainly reflecting recent monetary policy decisions – and the expected rebound in foreign demand later in the horizon should also support economic activity.

3 Prices and costs

Euro area headline inflation, as measured by the Harmonised Index of Consumer Prices (HICP), continues to stand close to the Governing Council’s 2% medium-term target. According to Eurostat’s flash estimate, it edged up to 2.1% in August 2025, from 2.0% in July.^[3]This increase was mainly driven by a rise in energy inflation, which more than offset a decline in food inflation. HIPC inflation excluding energy and food (HICPX) was unchanged, reflecting a decline in services inflation and stable non-energy industrial goods (NEIG) inflation. Measures of underlying inflation remain consistent with the ECB’s 2% medium-term target. Wage growth continues to moderate, with year-on-year growth in compensation per employee declining to 3.9% in the second quarter of 2025, down from 4.0% in the previous quarter and 4.8% in the second quarter of last year, as well as from 5.7% in the second quarter two years ago. Most measures of longer-term inflation expectations continue to stand at around 2%, supporting the stabilisation of inflation around the ECB’s target.

The September 2025 ECB staff macroeconomic projections for the euro area show a picture of inflation similar to that projected in June 2025 and foresee headline inflation averaging 2.1% in 2025, 1.7% in 2026 and 1.9% in 2027.^[4]

According to Eurostat’s flash estimate, euro area HICP inflation increased to 2.1% in August 2025, up from 2.0% in July (Chart 8).^[5] This increase resulted from a rise in the annual rate of change of energy prices, to -1.9% in August from -2.4% in July, that was mainly driven by upward base effects, i.e. annual energy inflation increased, while, month on month, energy prices declined. Although a detailed breakdown for August is not yet available, July’s data show an increase in the annual rates of electricity and transportation fuel prices, albeit with the latter remaining in negative territory; whereas gas prices decreased. Food inflation edged downwards, to 3.2% in August from 3.3% in July, driven by a decline in the year-on-year growth rate of processed food prices, to 2.6% from 2.7%, which was not fully offset by the increase in unprocessed food inflation, to 5.5% from 5.4%. For the fourth consecutive month, HICPX inflation remained unchanged at 2.3% in August, driven by the unchanged rate of NEIG inflation, at 0.8%, despite a slight decline in services inflation to 3.1% from 3.2%. Services inflation has been on a downward path over recent months. Following the July decomposition, the decrease in services inflation was primarily driven by a decline in recreational services inflation, notably for accommodation, package holidays and restaurant services.

Chart 8

Headline inflation and its main components

(annual percentage changes; percentage point contributions)

Most underlying inflation indicators were broadly unchanged in July and August 2025. In July, the range of the measures of underlying inflation remained relatively stable between 2.1% and 2.6%.^[6] Almost all exclusion-based measures, including HICPX inflation excluding travel-related services items, clothing and footwear (HICPXX) and the 10% and 30% trimmed means, were unchanged in July, at a rate of 2.5%, 2.1% and 2.3%, respectively. The exceptions were the weighted median indicator, which increased to 2.6% in July from 2.3% in June, and domestic inflation, which declined slightly to 3.6% from 3.7% in the same period, consistent with the recent moderation in services inflation. As for the model-based measures, the Persistent and Common Component of Inflation rose slightly to 2.2% in July, from 2.1% in June, and the Supercore indicator (which comprises HICP items sensitive to the business cycle) edged downwards to 2.5% in July after remaining at 2.6% for four months in a row. Most exclusion-based measures available for August remained broadly stable.

Chart 9

Indicators of underlying inflation

(annual percentage changes)

Most measures of pipeline pressures indicate that the gradual easing at the initial stages of the pricing chain is continuing, whereas conditions at the later stages remain largely unchanged (Chart 10). At the early stages of the pricing chain, producer price inflation for energy decreased to -1.2% in July 2025 from 0.0% in June, well below its peak of 7.8% in February. The annual growth rate of producer prices for domestic sales of intermediate goods continued its downward path since February, edging down to -0.3% in July from -0.1% in June. At the later stages of the pricing chain, domestic producer price inflation for non-food consumer goods increased slightly to 1.6% in July from 1.5% in June, whereas producer prices for the manufacturing of food products were unchanged at 1.9% in July. Import price inflation for manufactured food also continued to decline from its peak at 10.6% in January, dropping to 5.9% in July from 6.6% in June. For intermediate goods, the annual growth rate of import prices remained in negative territory and decreased to ‑1.8% in July, down from -1.5% in June. Similarly for energy, the annual growth rate of import prices declined to -13.1%, from -12.7% in the same period. Overall, import price inflation has fallen significantly below its peaks earlier this year, signalling a drop in inflationary pressures originating from an easing in foreign supply chain pressures, as well as reflecting the appreciation of the euro.

Chart 10

Indicators of pipeline pressures

(annual percentage changes)

Domestic cost pressures, as measured by growth in the GDP deflator, rose to 2.5% in the second quarter of 2025, up from 2.3% in the first quarter (Chart 11). The increase in the annual growth rate of the GDP deflator reflects a higher contribution from unit profits, which outweighed the smaller contribution from unit labour costs and unit net taxes. The slight moderation in unit labour costs reflects a decline in compensation per employee growth, for which the year-on-year growth rate decreased to 3.9% in the second quarter of 2025, down from 4.0% in the previous quarter. At the same time, this decline indicates a drop in the annual growth rate of the wage drift (to -0.3% in the second quarter of 2025, down from 1.2% in the previous quarter), which was partially offset by an increase in the growth rate of negotiated wages (to 4.0%, up from 2.5%, in the same period). This increase reflects a low growth rate of negotiated wages in the first quarter of 2025, which was partly driven by negative base effects stemming from large-one off payments made in the first quarter of 2024 that were no longer a factor in 2025. Looking ahead, the ECB’s wage tracker, which incorporates data on wage agreements negotiated up to the end of August 2025, suggests that wage growth pressures will ease in the second half of 2025 and stabilise in the first half of 2026.^[7] This further moderation is expected to reflect the normalisation of wage negotiations following a period of high wage demands to successfully (albeit only gradually) restore workers’ purchasing power relative to the fourth quarter of 2021. The September 2025 ECB staff macroeconomic projections for the euro area expect growth in compensation per employee to stand at 3.4%, on average, for 2025 and to continue moderating to 2.7% in 2026.

Chart 11

Breakdown of the GDP deflator

(annual percentage changes; percentage point contributions)

In the period since the July Governing Council meeting, there was little change in market-based and survey-based indicators of longer-term inflation expectations. Market-based measures of short-term inflation compensation remained broadly stable at levels below 2% (Chart 12). In both the ECB Survey of Professional Forecasters for the third quarter of 2025 and the ECB Survey of Monetary Analysts for September 2025, average and median longer-term inflation expectations remained at 2%. Shorter-term survey expectations for 2025 also stood at around 2%, with small changes reflecting recent data outcomes and movements in energy commodity prices. The one-year forward inflation‑linked swap rate one year ahead, a market-based measure of short-term inflation compensation, remained broadly stable at around 1.8%, increasing by 7 basis points since the June Governing Council meeting, as somewhat higher oil prices pushed up near-term inflation expectations, outweighing the downward impact of the appreciation of the euro. At medium and longer‑term maturities, the slight increase in inflation compensation primarily reflects a rise in inflation risk premia. This development left five‑year forward inflation-linked swap rates five years ahead, adjusted for inflation risk premia, close to 2%.

Consumers’ perceptions of past inflation and their short-term inflation expectations remained stable in July 2025, while their medium-term expectations increased slightly (Chart 12). According to the ECB Consumer Expectations Survey for July 2025, the median rate of perceived inflation over the previous 12 months also remained stable at 3.1% for the sixth consecutive month. Median expectations for headline inflation over the next 12 months were also unchanged at 2.6%, down noticeably from the 3.1% recorded in April 2025. However, median expectations for three years ahead rose slightly to 2.5% in July, up from 2.4% in June.

Chart 12

Market-based measures of inflation compensation and consumer inflation expectations

a) Market-based measures of inflation compensation

(annual percentage changes)

b) Headline HICP inflation and ECB Consumer Expectations Survey

(annual percentage changes)

The September 2025 projections expect headline inflation to average 2.1% in 2025 and 1.7% in 2026, before edging up to 1.9% in 2027 (Chart 13). Headline inflation is expected to remain close to 2% in the second half of 2025 and to fall below 2% in and throughout 2026. This lower rate of headline inflation in 2026 reflects a decline in services and food inflation, as well as a slightly negative rate of energy inflation. Headline inflation is subsequently expected to rise in 2027, primarily reflecting an upward impact from energy inflation linked to the introduction of a new EU Emissions Trading System 2. Compared with the June 2025 projections, the outlook for headline inflation has been revised upwards by 0.1 percentage points for both 2025 and 2026 and revised downwards by 0.1 percentage points for 2027. The upward revision reflects higher energy and food inflation, driven by higher than expected energy commodity prices, as well as the lagged impact of past increases in international food commodity prices, which outweighed the impact of the appreciation of the euro. For 2027, the lagged effects of the appreciation of the euro are expected to resonate, thus resulting in a downward revision. HICPX inflation is expected to decline from 2.4% in 2025 to 1.9% in 2026 and 1.8% in 2027, as wage pressures diminish and services inflation moderates, and also as the appreciation of the euro gradually feeds through the pricing chain to curb goods inflation. Compared with the June 2025 projections, HICPX inflation is broadly unrevised for 2025 and 2026, whereas it has been revised downwards by 0.1 percentage points for 2027.

Chart 13

Euro area HICP and HICPX inflation

(annual percentage changes)

4 Financial market developments

During the review period from 5 June to 10 September 2025, euro area short-term risk-free rates increased, while longer-term risk-free rates remained broadly unchanged. Long-term sovereign bond yields ended the review period higher and spreads over risk-free overnight index swap (OIS) rates widened somewhat, albeit with some variation across countries. Euro area equity markets traded mainly sideways and continued to underperform their US counterparts, as weaker earnings expectations for non-financial corporations (NFCs), especially exporters exposed to US tariffs, were broadly offset by the solid performance of the financial sector. Spreads in corporate bond markets tightened further, fully reversing the tariff-related widening observed earlier in the year. In the foreign exchange market, the euro appreciated both against the US dollar (2.8%) and in trade-weighted terms (2.1%). This reflected a downward repricing of rate expectations in the United States and improved sentiment towards the euro, supported by relatively robust euro area fundamentals amid concerns over US tariff policies and fiscal sustainability.

Euro area short-term risk-free rates moved higher during the review period, while longer-term risk-free rates remained broadly unchanged (Chart 14). The benchmark €STR stood at 1.92% at the end of the review period, following the Governing Council’s decisions to lower the three key ECB interest rates by 25 basis points at its June 2025 meeting and to keep them unchanged at its meeting in July. Excess liquidity decreased by around €57 billion to €2,651 billion. This mainly reflected the continuing decline in the portfolios of securities held for monetary policy purposes, which was partly offset by a decrease in euro-denominated liabilities such as government deposits. Very near-term forward rates rose notably following the Governing Council meetings in June and July. After the July meeting, near-term policy rate expectations drifted gradually higher, with the interest rate outlook showing limited reaction to incoming US tariff news, such as the EU-US trade deal announcement on 27 July, and to geopolitical tensions in the Middle East. By the end of the review period, the forward curve was pricing in cumulative interest rate cuts of 8 basis points by the end of 2025, down from 25 basis points priced in at the start of the review period. Looking further ahead, the €STR forward curve beyond 2027 remained broadly unchanged.

Chart 14

€STR forward rates

(percentages per annum)

Long-term sovereign bond yields ended the review period higher, with yield spreads widening somewhat (Charts 15 and 16). Notwithstanding some fluctuations, the ten-year nominal OIS rate remained broadly unchanged at 2.4% during the review period. Similarly, long-term real rates were largely stable as market participants took an overall neutral view of macroeconomic and geopolitical news during the period. The ten-year GDP-weighted euro area sovereign bond yield increased by 6 basis points to close at around 3.1%. Sovereign spreads over risk-free OIS rates widened at the end of the review period, with aggregate spreads increasing by 6 basis points, amid a global repricing caused partly by fiscal sustainability concerns in advanced economies. Against this backdrop, market participants paid closer attention to fiscal developments, particularly in France, where the announcement of a confidence vote for early September raised concerns about delays in fiscal consolidation. French sovereign yields increased by 20 basis points to stand at around 3.5% at the end of the review period. By contrast, Italian sovereign yields declined by 6 basis points, reinforcing the longer-running convergence trend in French and Italian sovereign spreads. Diverging from the global upward repricing, the ten-year US Treasury yield fell by around 35 basis points over the review period, to 4.1%. This decline was driven mainly by weaker than expected employment data released at the end of July and August, which led to a marked downward reassessment of near-term US policy rate expectations. As a result, the long-term interest rate differential between the euro area and the United States narrowed by approximately 35 basis points.

Chart 15

Ten-year sovereign bond yields and the ten-year OIS rate based on the €STR

(percentages per annum)

Chart 16

Ten-year euro area sovereign bond spreads vis-à-vis the ten-year OIS rate based on the €STR

(percentage points)

Euro area equity markets traded largely sideways over the review period, significantly underperforming their US counterparts (Chart 17). Euro area stock market indices remained unchanged over the review period as a whole, with the sub-index for NFCs declining by 1.5% while bank stock prices increased by 13.6%. Broad euro area indices gained on account of a strong revaluation of financial companies, which benefited from a trend steepening in yield curves and higher trading profits, broadly offsetting the weak performance of non-financial equities. By contrast, US stock market indices strengthened by around 10%, with gains of 14.6% for banks and 10.6% for NFCs. This divergence between the euro area and US stock markets was partly due to renewed interest in US technology stocks amid a strong earnings season. Euro area firms with greater revenue exposure to the United States significantly underperformed less exposed firms, reflecting expectations of tariffs weighing on future earnings. The announcement on 27 July of the EU-US trade agreement introducing 15% tariffs on EU exports to the United States had little immediate impact, suggesting that markets had largely anticipated its effect on corporate earnings.

Chart 17

Euro area and US equity price indices

(index: 1 January 2020 = 100)

In corporate bond markets, spreads on investment-grade and high-yield bonds narrowed further, fully recovering from the tariff-related spike earlier this year. Despite elevated trade uncertainty, risk sentiment in the corporate bond market improved over the review period, with spreads in the investment-grade and high-yield segments narrowing by approximately 11 and 17 basis points respectively. In the high-yield segment, spreads on NFC bonds decreased by 24 basis points, while spreads on bonds issued by financial corporations widened by around 41 basis points.

In foreign exchange markets, the euro appreciated both against the US dollar and in trade-weighted terms (Chart 18). During the review period, the nominal effective exchange rate of the euro – as measured against the currencies of 41 of the euro area’s most important trading partners – strengthened by 2.1%. The euro’s appreciation was broad-based overall, with gains against most major and emerging market currencies. Notably, it rose by 5.2% against the Japanese yen, which partly reflected uncertainties surrounding Japan’s political and monetary policy outlook. In contrast, it weakened slightly by 0.3% against the Swiss franc, which continues to serve as a safe haven during periods of heightened uncertainty. Against the US dollar, it rose by 2.8% on the back of a downward repricing in US interest rate expectations and improved sentiment towards the euro, supported by relatively robust euro area fundamentals amid concerns over US tariff policies and fiscal sustainability. Trade uncertainty eased somewhat following the conclusion of the EU-US trade agreement in late July, which contributed to a temporary sharp depreciation of the euro and renewed demand for the US dollar. The euro also remained sensitive to shifts in market expectations regarding US monetary policy, with weaker US labour market data in early August supporting the euro as markets adjusted their expectations for US interest rates.

Chart 18

Changes in the exchange rate of the euro vis-à-vis selected currencies

(percentage changes)

5 Financing conditions and credit developments

The past interest rate cuts continued to pass through to lower bank funding costs and corporate borrowing costs through July. Average interest rates on new loans to firms moved down to 3.5%, whereas average interest rates for households on new mortgages stood at 3.3%, having remained broadly stable since the start of the year. Growth in loans to firms and households continued to gradually recover but remained below historical averages, partly in response to elevated uncertainty. The growth of corporate bond issuance accelerated. Over the review period from 5 June to 10 September 2025, both the cost of market-based debt financing and, more notably, the cost of equity financing declined for firms on the back of narrowing corporate bond spreads and a lower equity risk premium respectively. The annual growth rate of broad money (M3) weakened, mainly owing to outflows from the non-bank financial sector, to stand at 3.4% in July.

Bank funding costs continued to decrease slowly through July 2025, reflecting the past policy rate cuts. The composite cost of debt financing for euro area banks − i.e. the index which measures marginal bank funding costs − fell slightly in July (Chart 19, panel a), reflecting the continued pass-through of the ECB’s past policy rate cuts to deposit rates and interbank rates. Bank bond yields have fluctuated at levels around 3.0% since the beginning of the year, amid temporarily higher volatility in financial markets, related notably to uncertainty about US tariffs that has recently been partly resolved (Chart 19, panel b). The composite deposit rate declined further to reach 0.9% in July, down from its peak of 1.4% in May 2024. This fall has been driven by lower interest rates on the time deposits of firms and households and, to a lesser extent, on their overnight deposits. Thus, despite remaining significant, the remuneration gap between time deposits and overnight deposits for both firms and households has been gradually narrowing since peaking in October 2023.

Chart 19

Composite bank funding costs in selected euro area countries

(annual percentages)

Bank lending rates for firms continued to decline, albeit at a slower pace, while mortgage rates for households remained broadly unchanged, reflecting differences in loan fixation periods. The cost of bank borrowing for non-financial corporations (NFCs) fell to 3.5% in July, a decrease of around 1.8 percentage points from its October 2023 peak (Chart 20, panel a). This decline was varied across euro area countries and uneven across maturities; it was most pronounced for medium-term loans with a maturity of between one and five years, driven by a number of large corporate loans. The spread between interest rates on small and large loans to firms narrowed in July. The cost of borrowing for households for house purchase remained broadly stable at 3.3% in July, around 80 basis points below its November 2023 peak, with minor variations across countries (Chart 20, panel b). The disparity between lending rates for households and those for firms mainly reflects differences in loan fixation periods. Household loans typically have longer fixation periods in many jurisdictions, making them less sensitive to fluctuations in short-term market rates. In line with the steepening of the yield curve, the gap between corporate and mortgage lending rates continued to narrow, standing 116 basis points below its all-time high reached in March 2024.

Chart 20

Composite bank lending rates for firms and households in selected euro area countries

(annual percentages)

Over the review period from 5 June to 10 September 2025, both the cost of market-based debt financing and the cost of equity financing declined for firms. The overall cost of financing for NFCs – i.e. the composite cost of bank borrowing, market-based debt and equity – declined in July compared with the previous month and stood at 5.6% (Chart 21).^[8] A sizeable drop in the cost of equity financing was the main driver of the fall in the overall cost of financing. All other cost components also declined, albeit to a lesser extent. Daily data for the review period from 5 June to 10 September 2025 show that both the cost of market-based debt and, more sharply, the cost of equity financing declined further. The decline in the cost of market-based debt was driven by the compression of corporate bond spreads in both the investment-grade and, most noticeably, high-yield segments. The fall in the cost of equity financing over the same period reflected a decline in the equity risk premium, while the long-term risk-free rate, as approximated by the ten-year overnight index swap rate, remained stable.

Chart 21

Nominal cost of external financing for euro area firms, broken down by component

(annual percentages)

Growth in loans to firms and households recovered gradually through July but is showing signs of levelling off and remains below historical averages. The annual growth rate of bank lending to firms edged up to 2.8% in July 2025, after 2.5% in May and 2.7% in June. However, it still remains below its historical average of 4.3% (Chart 22, panel a). The gradual increase in annual growth reflects convergence towards stable short-term dynamics. In this context, net issuance of corporate debt increased to 4.1% in July from 3.4% in June. Net issuance in July was in line with the average observed since the beginning of the year, pointing to a stabilisation in the development of this source of funding. Recent short-term dynamics of loans to households also remain broadly stable. The annual growth rate of loans to households edged up gradually to reach 2.4% in July, from 2.2% in June, but is still significantly below the historical average of 4.1% (Chart 22, panel b). Loans to households for house purchase were still the primary driving force behind this upward trend, with consumer credit growth remaining stable at 4.6% in July. The recovery in loans to households appears to have lost momentum, however, as indicated by weaker monthly flows driven by mortgages despite the sustained housing demand reflected in survey data. Other forms of household lending, including loans to sole proprietors, remained weak. Household sentiment regarding credit access remained broadly stable. According to the ECB’s Consumer Expectations Survey, perceived credit access was unchanged overall in June and July, but households reported increasing difficulties in meeting their mortgage payments. Looking ahead, households expect credit access to remain unchanged over the next 12 months.

Chart 22

MFI loans in selected euro area countries

(annual percentage changes)

Growth in broad money (M3) has slowed since May (Chart 23). Annual M3 growth stood at 3.4% in July, below the 3.9% average observed in the first five months of 2025. Annual growth of narrow money (M1), which comprises the most liquid components of M3, stood at 5.0% in July, a level around which it has been hovering since April. Non-core, volatile items appear to have played an important role in the recent dynamics of M3. From the perspective of individual components, the July data were driven by outflows of deposits held by non-bank financial institutions, partly reflecting heightened volatility. This contrasts with the contribution of households and firms, which remained stable overall. Amid the uncertain environment, both sectors showed a greater preference for liquidity and increased their holdings of overnight deposits accordingly. Moreover, households and firms paused their net withdrawal of time deposits, in line with a possible levelling off in the remuneration of these deposits. From the counterpart perspective, the July data reflect continued volatility in bank lending to firms, net foreign outflows and further volatile, non-structural components.

Chart 23

M3, M1 and overnight deposits

(annual percentage changes, adjusted for seasonal and calendar effects)

6 Fiscal developments

According to the September 2025 ECB staff macroeconomic projections for the euro area, the general government budget deficit, which stood at 3.1% of GDP in 2024, is estimated to decline to 2.9% in 2025 and then increase substantially to 3.4% of GDP in 2027. The euro area fiscal stance is projected to tighten only slightly in 2025, loosen in 2026 and then tighten again, somewhat more strongly, in 2027. The projected loosening in 2026 is mainly on account of higher public investment. The tightening in 2027 reflects primarily lower assumed government spending related to the discontinuation of the grants offered under the Next Generation EU (NGEU) programme. The euro area debt-to-GDP ratio is on an increasing path and projected to reach just under 90% of GDP by 2027, as the continuous primary deficits and positive deficit-debt adjustments more than offset favourable interest rate-growth differentials.

According to the September 2025 ECB staff macroeconomic projections, the euro area general government budget balance is expected to decline over the projection horizon (Chart 24).^[9] The euro area budget deficit declined from 3.5% in 2023 to 3.1% of GDP in 2024. This was due to the unwinding of most of the remaining energy and inflation-related fiscal support measures. Looking ahead, it is expected to fall to 2.9% in 2025 but then increase to 3.2% of GDP in 2026 and further to 3.4% of GDP in 2027. This increase is mainly on account of higher interest payments, as longer maturity debt matures and is refinanced at higher interest rates, but also due to a slight deterioration in the cyclically adjusted primary balance and the cyclical component.

Chart 24

Budget balance and its components

(percentages of GDP)

Compared with the June projections, the budget balance has been revised upwards over the entire projection horizon, though mostly as of 2026. This improvement is driven by expectations that discretionary fiscal policies will be enhanced in 2026, then partly reversed in 2027. The budgetary tightening is mostly on account of upward revisions in net indirect taxes in Germany in the context of the 2026 budget discussion. These revisions relate to a lower than previously endorsed cut in the electricity tax and a lower increase in subsidies (linked to the electricity grid fee). Other sources of revisions include lower expected government consumption growth (relative to nominal potential GDP), particularly in France but also in Spain, as well as higher direct taxes on households in France. In 2027 a marginally less tight fiscal stance than foreseen in June mainly reflects upward revisions in government consumption and fiscal transfers in several countries, particularly Italy and the Netherlands. As a result, the euro area budget deficit as a percentage of GDP has been revised down by 0.2 percentage points in 2026 and by 0.1 percentage points in 2025 and 2027.

The euro area fiscal stance is projected to tighten only slightly in 2025, to loosen in 2026 and to tighten again somewhat more strongly in 2027.^[10] After a significant tightening in 2024 on account of both non-discretionary factors and fiscal policy measures, the fiscal stance is projected to tighten only slightly in 2025 – mostly due to discretionary revenue measures. These include increases in social security contributions and, to a lesser extent, higher indirect and direct taxes. These tax increases are partly offset by continued growth in public spending. In 2026 the fiscal stance is projected to loosen, mainly on account of higher public investment. This reflects the higher defence and infrastructure spending already incorporated in the baseline for the June projections, particularly stemming from Germany (2026-27), as well as high NGEU-funded investment growth in Italy, Spain and some other countries. In 2027 the tightening in the NGEU-adjusted fiscal stance primarily reflects lower assumed government spending, as NGEU grant financing expires.

The euro area debt-to-GDP ratio is projected to increase slowly from 87.4% in 2024 to just below 90% in 2027 (Chart 25). The euro area debt-to-GDP ratio is seen on an increasing path as the ongoing primary deficits and positive deficit-debt adjustments more than offset the favourable, though rising, interest rate-growth differentials. Compared with the June projections, the debt ratio has been revised down, mainly on account of the lower cumulative primary deficits.

Chart 25

Drivers of change in euro area government debt

(percentages of GDP, unless otherwise indicated)

The draft budgetary plans for 2026, which EU governments should submit by 15 October 2025, should underpin the execution of the medium-term fiscal plans. Governments should ensure sustainable public finances in line with the EU’s economic governance framework, while prioritising essential growth-enhancing structural reforms and strategic investment. At the euro area level, a consolidation of public finances, designed in a growth-friendly manner, will be necessary over the coming years.

Boxes

1 How vulnerable is the euro area to restrictions on Chinese rare earth exports?

Prepared by Mattia Banin, Mario D’Agostino, Vanessa Gunnella and Laura Lebastard

On 4 April 2025 China imposed export restrictions on rare earth elements, raising production challenges for some firms. The measures were introduced in retaliation for increased US tariffs on Chinese goods during escalating US-China trade tensions. They restrict Chinese exports of rare earth elements, compounds and related products, such as permanent magnets that are used across the defence, electric vehicle, energy and electronics industries (European Commission, 2020). The decision caused a supply shock: in May Chinese shipments of rare earth magnets dropped by approximately 75% compared with the previous year, which forced some carmakers to pause production.

2 Consumer expectations and actions during the recent trade tensions

Prepared by Adam Baumann, Luca Caprari, Maarten Dossche, Georgi Kocharkov and Omiros Kouvavas

Recent trade tensions and tariff announcements are significantly affecting the behaviour and expectations of European consumers. ECB Consumer Expectations Survey (CES) data collected in June 2025 reveal that European consumers expect tariffs to adversely affect inflation, household finances and economic growth.^[11] A net balance of 40% of respondents view the tariffs as inflationary, a net balance of 13% see them as having a negative impact on their finances, and a net balance of 24% believe the tariffs will dampen economic growth (Chart A).

3 Manufacturing versus services: how frontloading and uncertainty shaped recent developments

Prepared by Niccolò Battistini and Johannes Gareis

Manufacturing activity returned to growth in early 2025, while services activity slowed, marking a reversal of the previous trends in the two sectors. Hard data on production show that manufacturing activity contracted significantly in 2023 and 2024. In the first quarter of 2025, however, manufacturing rebounded as the contraction in the euro area excluding Ireland came to an abrupt halt, while the expansion in Ireland accelerated (Chart A). By contrast, services activity, which had continued to expand in the previous two years, lost momentum. Survey data on business perceptions from the European Commission corroborate this reversal. Manufacturing firms indicated a marked rise in perceived activity, which, however, remained below its long-term average. Conversely, services firms reported a fall in perceived activity below its historical norm. The earlier divergence between manufacturing and services reflected the energy-induced inflation surge and the ensuing monetary policy tightening, which weighed particularly on manufacturing, while services were supported by the post-pandemic normalisation of consumption patterns.^[12] While some of these drivers have reversed, new factors have emerged. Temporary frontloading ahead of higher US tariffs likely supported the manufacturing rebound, while rising uncertainty surrounding trade policy (and, more broadly, economic policy) appears to have dampened overall activity. This box examines frontloading and trade policy uncertainty through the lens of granular sectoral data and discusses the short-term outlook for manufacturing and services activity.

4 Are workers willing to accept pay cuts in exchange for remote working flexibility?

Prepared by António Dias da Silva and Marco Weissler

Since the pandemic, working from home has become more common in the euro area.^[13] According to Eurostat, the share of employees aged 20-64 who at least sometimes worked from home doubled between 2019 and 2024, from 11.7% to 22.4%.^[14] Among respondents to the ECB Consumer Expectations Survey (CES), working from home was even more common than this, as in May 2024, 33.6% of employees reported working at least two days per week from home. This discrepancy could be attributable to methodological differences and, given that the CES is conducted online, to potential sampling differences. The CES also shows that these remote working patterns seem to have become well established, having remained broadly stable from 2024 to 2025. Non-wage benefits – including remote working possibilities – are often offered by firms as an alternative to higher wages. Previous international research on this question has often found that employees would be willing to forgo a part of their wages in exchange for being able to work from home (Aksoy et al., 2022, Nagler et al., 2024 and Cullen et al., 2025). This box analyses how much euro area employees value having the option to work from home.

5 Monitoring attention to inflation in the news

Prepared by Ilias Aarab, Marta Bańbura, Elena Bobeica and Emma Leguay

The degree of attention people devote to inflation can affect inflation expectations, the pass-through of shocks to inflation and the transmission of monetary policy. Specifically, the level of attention shapes how inflation expectations are formed, which are central to price and wage dynamics. Attention to inflation varies over time.^[15] When it is high, expectations are more sensitive to developments, potentially leading to a stronger and faster pass-through to actual prices and wages. Research also shows that responsiveness to monetary policy can differ between those who are attentive to inflation and those who are not. As such, the degree of attention may influence the effectiveness of monetary policy transmission (Pfäuti, 2024; Song and Stern, 2024).

6 Liquidity conditions and monetary policy operations from 23 April to 29 July 2025

Prepared by Samuel Bieber and Vladimir Tsonchev

This box describes the Eurosystem liquidity conditions and monetary policy operations in the third and fourth reserve maintenance periods of 2025. Together, these two maintenance periods ran from 23 April to 29 July 2025 (the “review period”).

Articles

1 Macroeconomic impacts of higher defence spending: a model-based assessment

Prepared by Nikola Bokan, Pascal Jacquinot, Magdalena Lalik, Georg Müller, Romanos Priftis and Rodolfo Rigato

This article uses a suite of models to analyse the macroeconomic impact of higher government defence spending. In June 2025 members of the North Atlantic Treaty Organization (NATO) committed to increase core defence and other related spending by a volume unprecedented in recent history. In light of this pledge, we revisit the size of fiscal multipliers and their determinants across a range of ECB macroeconomic models. This article complements previous ECB analyses by highlighting the role of model differences in the quantification of economic effects of public spending.^[16]

2 Keep calm and carry cash: lessons on the unique role of physical currency across four crises

Prepared by Francesca Faella and Alejandro Zamora-Pérez

Demand for euro banknotes has exhibited robust growth despite ongoing payment digitisation. While the share of cash in daily transactions has declined in the euro area, the value of euro banknote circulation has significantly increased over the past two decades (Chart 1, panel a). This variable serves as a reliable indicator of overall demand – domestic and foreign – as the Eurosystem accommodates requests for banknotes. In fact, the value of outstanding banknotes has consistently maintained a share of over 10% of euro area GDP over the last ten years, with a temporary increase during the COVID-19 pandemic years and a moderation since the second half of 2022 due to higher interest rates. It also represents a consistent portion of around 10% of M3 (broad money) – a measure encompassing other liquid, euro-denominated assets. The sustained demand for cash, despite the proliferation of digital payment alternatives, suggests its distinct utility and imperfect substitutability. This stable overall demand contrasts with the diminishing share of cash in everyday payments, a phenomenon often termed “the paradox of banknotes” (Zamora-Pérez, 2021).

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