Euro zone to grow faster than expected, but defence spending boosts debt, EU Commission says

By Jan Strupczewski

BRUSSELS (Reuters) -The euro zone economy is likely to expand faster than expected this year and grow at or above potential in 2026 and 2027, but debt and deficit will be on the rise too because of defence spending, the European Commission said on Monday.

The EU executive arm forecast that gross domestic product in the 20 countries that share the euro currency would grow 1.3% this year, more than the 0.9% forecast in April and up from 0.9% growth in 2024.

The faster growth is mainly thanks to a surge in exports in the first six months ahead of expected tariff increases.

In 2026, growth is to slow marginally to 1.2% before accelerating again to 1.4% growth in 2027, staying at or above the potential growth rate of 1.2%.

But despite the decent growth rates euro zone public finances will continue to deteriorate as governments spend to prepare for a potential attack from Russia, the Commission said.

"We see both budget deficit and debt to GDP ratio edging up over the forecast horizon and the main driver of this is defense spending," Economic Commissioner Valdis Dombrovskis said.

The euro zone's aggregated budget deficit is to rise to 3.2% of GDP this year from 3.1% last year and increase further to 3.3% in 2026 and 3.4% in 2027.

The budget deficit of the euro zone's biggest economy Germany is to jump to 4.0% of GDP next year from 3.1% this year and 2.7% in 2024, mainly as a result of higher defence spending as well as higher spending on infrastructure.

The second biggest euro zone economy France is to cut its budget gap to 5.5% of GDP this year from 5.8% in 2024 despite its government crisis, the Commission forecast. The French budget gap is to fall to 4.9% in 2026, it forecast.

EU countries are obliged to keep budget deficits below 3% of the GDP, but faced with the threat from Russia, the Commission, which is the guardian of EU laws, said governments can spend an additional 1.5% a year for four years without any punitive action from the EU.

"But obviously it's important that member states use this period of fiscal flexibility ... to adjust their budgets to structurally higher defence expenditures ...to be able to return to the normal fiscal trajectory," Dombrovskis said.

Aggregated euro zone public debt is also to increase, the Commission said, going up to 88.8% of GDP this year from 88.1% in 2024 and then to 89.8% in 2026 and 90.4% in 2027.

(Reporting by Jan Strupczewski, Editing by William Maclean)