“The Year That Was and Will Be”

This is my final blog of the year and it’s longer than usual as I want to reflect on Ireland and the euro area’s economic performance in 2025 and look ahead to 2026, drawing on today’s Quarterly Bulletin and the latest eurosystem staff projections published yesterday.

The economic narrative in 2025 has been dominated by geopolitical events that are reshaping the global economy. As a small, open economy, Ireland is exposed to these developments. We have yet to see the full fallout from increasing US tariffs. One thing we can be sure of in 2026 is that we need to prepare for the unexpected, building resilience in our own and the euro area economy.

Ireland

With respect to the Irish economy, resilience has already been evident in 2025 in the face of the significant changes we are seeing to cross-border trade and investment. In our latest Quarterly Bulletin, we have upgraded our outlook for Irish economic growth driven mainly by more positive momentum in investment by foreign-owned multinationals. 

These businesses appear to be adapting to the emerging global realities and, so far, this has not resulted in a significant drag on their activities in Ireland.

However, it remains the case that headline growth and exports are significantly concentrated in the activities of relatively few firms in the pharmaceuticals and ICT services sectors, while there is also meaningful employment in these sectors.  This concentration of economic activity –  and the related profit that generates corporation tax receipts – increases Ireland’s sensitivity to geoeconomic developments. As a result, downside risks to the growth outlook remain since the value and volume of multinational activity in Ireland is sensitive to more significant shifts in US industrial policy in particular.

Meanwhile, the pace of growth in the more domestically-focused sectors of the economy is slowing, which is also reflected in cooling labour market conditions. This isn’t surprising, given the domestic economy has been operating at or above potential for a number of years. Related to this, more domestically-determined inflation, most notably in services, appears to have moved into a higher medium-term range than what was the case for the decade and a half before the pandemic. 

Since that time, and especially since the Russian invasion of Ukraine, overall HICP inflation (the measure that is the basis of the ECB’s 2% target) has been significantly influenced by movements in goods prices. More recently, energy price reductions last year and stronger food price increases from early 2025 have contributed to variability in headline HICP inflation.  However, the greater persistence of underlying services inflation now underpins a higher forecast for Irish headline HICP inflation than in the outlook we published in September, averaging closer to 2 per cent out to 2028. At the same time, evidence from the ECB Consumer Expectations Survey suggests that Irish consumers’ perceptions and expectations of inflation have risen in 2025 and moved further above those for consumers in the euro area overall. This is something we will continue to monitor closely, for any signs of subsequent upward wage pressures.

One striking feature of the current combination of domestic growth and inflation is that underlying inflation is persistent even as growth has been reasonably well spread across sectors with different productivity profiles. Looking ahead, with the scale of increase in construction sector activity envisaged to deliver necessary infrastructure and housing, typically lower productivity sectors will account for a relatively larger share of overall domestic activity. This combination has the potential to make the economy more sensitive to external price shocks as well as to more domestically-generated inflationary pressures.  

With monetary policy reacting as appropriate for euro area-wide conditions, this brings back into focus the need for domestic policy to manage the delivery of necessary infrastructure and housing, which are acting as constraints on sustainable growth. This can be achieved alongside maintaining resilience in the economy and public finances to structural changes in demographics, climate, technology and geoeconomics.

Domestic policy should be (prudently) ambitious in addressing these challenges, in order to maintain Ireland’s attractiveness to FDI while strengthening the domestic economy’s capacity to deliver long-term prosperity.

For fiscal policy this means keeping a sustainable medium-term orientation, anchoring expenditure growth to the economy’s sustainable revenue-raising ability, and improving the stability of the tax base by broadening it and reducing concentration risk. Doing so will create both the fiscal and economic space for the necessary rise in public and private investment.  To underpin credibility and ensure sound public finances over the medium-term, it is important that a sustainable path for net spending growth is set out (and, of course, adhered to).

On the supply side, accelerating delivery of enabling infrastructure –  particularly water, energy and transport – to unlock housing delivery is paramount. I welcome recent initiatives such as the Accelerating Infrastructure Action Plan. Maximising the availability of serviced land in high-demand areas and deploying productivity-enhancing technologies in construction could help expand supply without generating excessive labour demand and inflationary pressures.

Finally, aligning labour supply with evolving technological and demographic realities is essential. Embracing AI’s potential while investing in skills, migration policies, and participation among older workers will help Ireland manage inflation risks and foster sustainable living standards growth.¹

In summary, Ireland’s economic outlook is shaped by the robust but sometimes volatile performance of globally-integrated multinationals, alongside a domestic economy facing capacity constraints and more persistent inflationary pressures. Navigating this complex environment calls for prudent, balanced policy actions that support investment and innovation while addressing supply‑side bottlenecks and ensuring fiscal and macroeconomic sustainability. Such an approach will be critical to securing Ireland’s long-term prosperity in a fragmented and unpredictable global economy.

Euro area

Yesterday the ECB’s Governing Council decided to leave its 3 key interest rates unchanged. The Deposit Rate – the effective monetary policy rate – is 2%, down from 3% at the beginning of the year.

At our meeting, we discussed the inflation and growth outlook for the euro area. Following a small inflation undershoot in 2026 and 2027 (1.9 and 1.8% respectively), staff projections expect inflation to return to our 2.0% target in 2028. The undershoot largely reflects base effects from energy prices. Core inflation, which excludes more volatile energy and food prices, fluctuates in a range of 1.9-2.2% over the projection horizon.

Growth projections have also been marginally revised up, to 1.4% in 2025, 1.2% in 2026 and 1.4% in 2027/28. Some of the near-term uplift reflects the better-than-expected performance of the Irish economy on the trade front. Although it accounts for a small percentage of overall GDP (around 3%), outsized movements in net exports in Ireland during 2025 have impacted growth estimates for the euro area as a whole. 

With interest rates unchanged since June of this year, my fellow Governing Council members and I are increasingly asked what the direction of the next interest rate change might be, i.e., up or down? In my view, it is too difficult to provide a definitive answer as the risks to inflation and growth are so wide-ranging. That is why I argued for the continued adherence to “data dependence” and the “meeting-by-meeting” approach, as communicated in our monetary policy statement yesterday. It keeps all options on the table, allowing us to respond to developments as they become clearer.

This does not mean our monetary policy is backward-looking. In an increasingly uncertain world, one of the key changes we made to our Monetary Policy Strategy Statement earlier in the year was that it should “[take] into account not only the most likely path for inflation and the economy but also surrounding risks and uncertainty, including through the appropriate use of scenario and sensitivity analyses.”

For me, risks are currently two-sided. In other words, there are factors that could lead inflation or growth to be lower or higher than the projections we have just published.

For example, wage growth in some countries – primarily in Germany, but also Italy – has turned out to be stronger than expected.  It remains to be seen whether or not this is a blip.  It should be said that wage trackers, which tend to be a reliable leading indicator of wage growth, point to continued deceleration in wage growth in 2026.  And labour demand in the euro area is easing, as we see from the drop in job vacancies. Potentially off-setting this easing in demand is the downward pressure on labour supply from ageing populations and a return of net inward migration to more historical norms.  As I have said before, this interaction of cyclical developments with ongoing structural trends presents a particular challenge for the calibration of monetary policy.²

How China adapts to the changing geopolitical landscape, and how the EU reacts is another two-sided risk. Downside risks to inflation could stem from the increasing flow of Chinese final and intermediate goods into Europe, putting downward pressure on goods prices. Relatedly, increasing competition from China could put pressure on the profitability of euro area firms.

The December projections have domestic demand (consumption plus investment spending) as the key driver of euro area growth. Consumption growth is driven by higher real incomes, in large part due to wage growth. Thus, the path for wages will also have a bearing on overall growth. The euro area savings rate spiked during the pandemic and has remained high since, reaching 15.4% in Q2, up from 12.6% at the end of 2019. Were this increase to unwind, this would represent a significant boost to consumption. 

Investment is expected to average 2.3% for 2026-28, only marginally above the long-term (1995-2019) average of 1.9%.  Over the projection horizon, investment is driven by a combination of tailwinds including reduced uncertainty, increased defence and infrastructure spending. As productivity becomes a central driver of euro area growth in the future – something I return to below – one question I have is whether this level of investment is sufficient to achieve the uplift required as set out in Mario Draghi's report. In addition to the scale of spending, it is also essential to understand the type of investment being undertaken, i.e., is it infrastructure-related, or more R&D and innovation-related, including intangible investment in relation to new technologies such as AI.

Finally, climate and geopolitical events continue to drive high-levels of volatility in both energy and food prices, and I continue to see the risks here as mostly two-sided: that is, prices could rise or fall.  Accounting for a quarter of spending for the average Irish household, developments here have an impact the cost of living, especially for lower income households who tend to spend more on both. For Irish consumers, energy prices fell for much of the year, before rising again in the last three months. However, Gas Futures prices have fallen, which could provide some respite in 2026.  For food prices, the outlook here remains sensitive to unexpected supply and demand shocks that often impact specific products. We saw this in meat products for Irish consumers – and globally – during 2025, as highlighted in our third Quarterly Bulletin. Current indications are for these pressures to ease, which should slow the rise in meat prices.  At the euro area level, the main risks to food inflation relate to international commodity prices and extreme climate events, especially extreme summer heat. The recent easing of cocoa and coffee prices and the fading impact of summer-weather events will provide some near-term respite. 

Building resilience is key

If 2025 has taught us anything it is that building resilience to events that seem previously unimaginable must now be a core part of economic policy and planning. In a recent speech, I highlighted some specific areas requiring urgent attention to address this potential "Knightian Uncertainty".

For Ireland, I have already mentioned the pressing need to close the infrastructure gaps in the economy in a sustainable manner. But in addition to housing, transport, telecommunications, energy and water we also need to plan for the shocks that could be created by bad actors. Security considerations are in an important part of resilience that we cannot ignore. We see this daily at the Central Bank of Ireland, where a core part of our work focuses on the operational resilience of the financial system.

For Europe, there remains significant untapped potential in realising the benefits of Europe’s Single Market. The reports by Mario Draghi and Enrico Letta make that clear that Europe’s current path is not one that can sustainably deliver prosperity for its citizens.

Addressing barriers to complete the single market and build a vibrant capital market will leverage the potential in Europe’s economy and mobilise the potential of its savings. As growth in the working age population slows, and ultimately shrinks in many countries, productivity growth – essentially the ability to do more with the same or fewer labour inputs – becomes the main driver of economic growth. Channelling European savings to investment, which in turn drives innovation, is key to this. 

Conclusion

Reflecting on 2025’s economic performance, it is worth remembering that only as recently as June we were publishing scenarios for euro area growth ranging from 0.5 to 1.2%, depending how "severe" or "mild" the fallout from tariffs and the spike in uncertainty might be.  The December projections now expect 2025 GDP growth to be 1.4%, even better than the "mildest" case.

This better-than-expected turn of events can be attributed to probably two things. First the eventual tariffs were significantly lower than initially mooted. And second, as highlighted for Ireland above, firms have proved remarkably adaptable to this new environment, for now. In this sense, a report card for the Irish and euro area economies might read as follows: a good year, in the face of significant geopolitical and geoeconomic upheaval, and, for now, performing around potential. 

My main "work-on" is a forward-looking one: continue to build resilience that will allow us to withstand the “known unknowns” and “unknown unknowns” that will inevitably come our way in the future.

Gabriel Makhlouf

[1] I discussed the interaction of technology and the labour market at my OECD lecture in September.