European growth to hold up but at an increasing fiscal cost, IMF says

FRANKFURT (Reuters) -Euro zone economic growth will hold up despite a drag from U.S. tariffs but this will come at a cost of higher government spending and rising debt, the International Monetary Fund said on Tuesday in an update of its World Economic Outlook.

The 20 nation currency bloc has been surprisingly resilient to trade tensions this year and policymakers are debating whether this is sustainable or a hit is still coming given that the U.S. is by far its biggest export market and the effective tariff rate has risen to 13% from 2.3%.

Economic growth in the euro area is now seen at 1.2% this year, above the 1% forecast in July and 2026 is seen at 1.1%, a downgrade from 1.2%, the IMF said.

The figures represent a cumulative downgrade compared to projections made a year ago as uncertainty takes its toll and even this relatively good performance comes at a high fiscal cost.

"Elevated uncertainty on multiple fronts and higher tariffs are the main drivers," the IMF said. "Recovering private consumption from higher real wages and fiscal easing in Germany in 2026 provide only a partial offset."

The fiscal balance will worsen mostly on Germany's big push to spend on defence and infrastructure, lifting the euro area's debt-to-GDP ratio to 92% by 2030 from 87% in 2024, the IMF said.

With growth relatively stable at potential and debt rising, inflation is also likely to stay level near the European Central Bank's 2% target and this is why the IMF predicted a steady deposit rate at 2% through 2029.

The IMF also noted that exporters on the whole have not absorbed U.S. tariffs and the export price of German cars sold to non-EU countries has remained relatively stable so far, a hopeful sign for Europe's large industrial sector.

Nevertheless, the impact of protectionist measures on the global economy is likely to intensify as a host of factors that provided temporary relief are likely to wane.

"There are increasing signs that the adverse effects of protectionist measures are starting to show," the IMF said. "As the global economy slides into a more fragmented landscape, risks to the outlook increase."

It argued that strategies that keep activity seemingly resilient, such as trade diversion and rerouting, are costly and the drag from shifting policies is becoming visible in more recent data.

(Reporting by Balazs KoranyiEditing by Alexandra Hudson)