A combination of heightened geopolitical risks, economic uncertainty and mounting fiscal pressures is setting the stage for a difficult year ahead for EU member states and the United Kingdom. That is the central conclusion of a new report by Moody’s, titled Outlook for 2026: Negative due to geo-economic and geopolitical risks and fiscal challenges.
According to the US credit rating agency, the outlook for the EU’s core credit fundamentals in 2026 is negative, as Europe finds itself exposed to shifting geopolitical and geo-economic dynamics. China’s dominance in critical raw materials, combined with trade frictions with the United States, is weighing on Europe’s economic resilience. At the same time, geopolitical risk remains elevated due to continued threats from Russia and the possibility of a reduced US role as guarantor of European security.
Growth and competitiveness under strain
Moody’s notes that weakening competitiveness and long-standing structural constraints continue to undermine growth prospects across the bloc. After three consecutive years of below-potential growth, EU real GDP is expected to recover only modestly, reaching around 1.4% in 2026.
While Germany’s large fiscal stimulus package is expected to support growth and spill over into other European economies, several factors are still acting as a drag. These include declining competitiveness linked to persistently high cost levels, demographic ageing, and ongoing geopolitical and geo-economic shifts.
Defence spending adds to fiscal pressure
The report also highlights the growing fiscal impact of increased defence spending. While higher military outlays strengthen regional security, they add to already rising budgetary pressures.
Public debt and debt-servicing costs are expected to deteriorate for most European countries in 2026. By contrast, debt metrics in Greece, Cyprus, Portugal and Ireland are projected to continue improving. As a result, while several of the EU’s larger economies face mounting fiscal challenges, some smaller states, including former bailout countries, are showing clearer improvement in their public finances.
The outlook is further complicated by increasing political fragmentation across the continent, with nine elections scheduled in 2026. These include six parliamentary elections in Cyprus, Denmark, Hungary, Latvia, Slovenia and Sweden, and three presidential elections in Bulgaria, Estonia and Portugal.
Moody’s warns that divided parliaments and domestic political risks are making policymaking more complex, limiting the scope for reforms. In countries such as France and Poland, political fragmentation is already complicating fiscal consolidation and structural reform efforts. Even so, the agency underlines that strong institutional frameworks across the EU and the UK continue to act as an important stabilising force.
Strong institutions as a buffer
Despite the negative outlook, Moody’s points to the strength of European institutions as a key line of defence against uncertainty. Countries such as Denmark, Finland, Luxembourg, the Netherlands, Sweden, Germany and Ireland are cited as having some of the world’s strongest institutions and most effective policymakers.
The agency notes that the outlook could shift to stable if geopolitical risks ease significantly and uncertainty around tariffs diminishes. A stronger economic recovery and faster implementation of reforms, leading to a sustained increase in trend growth, would also support creditworthiness. Fiscal reforms aimed at managing rising spending pressures and stabilising public debt would be another positive factor.
Cyprus: a cautious wait-and-see stance
In its most recent assessment of Cyprus, Moody’s adopted a wait-and-see approach. The agency highlights emerging challenges linked to population ageing, rising spending pressures, including from the recent cost-of-living allowance agreement, and residual risks in the banking sector.
While Cyprus’s small size makes it more vulnerable to shocks than larger economies, Moody’s stresses that the country benefits from solid institutional capacity and generally effective policymaking. Public debt continues on a firm downward trajectory and debt-servicing indicators remain stable.
At the same time, the agency flags ongoing credit challenges, notably the limited size of the economy and rising expenditure pressures tied to public sector wages and ageing-related costs. It also describes Cyprus’s fiscal policy as pro-cyclical, with structural spending increases alongside temporary revenue overperformance, leaving the country exposed to costly fiscal shocks.
Upside and downside risks
Moody’s suggests Cyprus’s ratings could be revised upwards if fiscal and debt metrics outperform current projections on a sustained basis, or if medium-term growth exceeds expectations. Stronger-than-anticipated private and public investment, higher foreign direct investment, improved labour market trends or a greater-than-expected impact from the Recovery and Resilience Plan could all support a more positive reassessment.
Conversely, ratings could come under pressure if fiscal outcomes fall well short of expectations, reversing the downward path of public debt. This could result from looser fiscal policy, faster-than-expected growth in public sector wage costs or escalating healthcare spending pressures.
The agency also notes that the exploitation of natural gas resources, which are not currently factored into fiscal projections, could provide a medium-term upside to Cyprus’s credit profile if realised.