Europe stock market outlook 2026: a great place for UK investors

The two biggest economies in Europe faced political struggles in 2025. Those issues, plus the long-running and continuing problems of an ageing population that will put increasing strain on the public coffers, have not entirely gone away.

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Of Germany and France, the problems are distinctly more serious in the latter. The current French constitution, the Fifth Republic, was established in 1958 to suit specific circumstances, namely the collapse of the previous political order with its changes of government and annual devaluations, and the return of war hero General Charles de Gaulle to sort out the mess.

The resulting American-style system of a separate executive and legislature sometimes leads to a president and parliament at loggerheads, with elections not coinciding. So it has been in France since President Emmanuel Macron made the disastrous decision to call parliamentary elections in 2024 that resulted in a fragmented chamber with no party in overall control, but most parties united in opposing the president.

The major bone of contention is an important one. Macron wishes to get the ballooning government deficit and debt mountain under control before they get any further out of hand. This has echoes of the 1950s, although the situation is not as bad as it was then. The European Union (EU) has over the years forced a considerable degree of financial rectitude on all its members.

The biggest bone of contention in the president’s proposals was a plan to raise the retirement age from 62 to 64. That was at a time when he also planned to increase defence spending each year to 2029 to counter the Russian threat to Nato. Given US President Donald Trump’s exhortation to Europe to take on a greater role in Nato, Macron can hardly do less than target 3.5% of GDP for defence. However, this has been a gift to left wing anti-war opponents.

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Protests are not new to France, and the current wave seems to have attracted less support than in the past for issues such as agricultural reform, transport and fishing rights, but the impact this time has, if anything, been greater thanks to the use of social media. Impetus has been added by the political right and left coming together in opposition to the president.

The organisers were difficult to identify – indeed, the protests appeared to be leaderless – and the violence widespread. The worst incidents came in September when riot officers had to use tear gas to disperse rioters in Paris and other major cities. There were running battles, road blockages, the throwing of concrete slabs at police officers and arson attacks.

The French Assembly has voted down proposed Budgets by a succession of short-lived premierships – including one hapless prime minister on two separate occasions. With each party in a fragmented parliament drawing its own set of red lines that it refuses to cross, the only majority policy that the parties can agree on is rejection of Macron.

An uneasy peace was restored when Macron’s latest government finally bowed to the inevitable and abandoned the policy of raising the retirement age. With hopes of increasing taxes by €14 billion (£12.3 billion) and reducing spending by €17 billion now out of the window, it is anyone’s guess how France will cope with a national debt pile of €3.3 trillion and rising. The current budget deficit is running above 6% against a EU target of 3%.

France is, meanwhile, left in the hands of a lame duck president whose term runs to April 2027, who has no intention of quitting early but who has no chance of establishing a parliamentary majority in the meantime.

The situation in Germany is more stable but is potentially as dire financially. Excluding the blip at the height of the Covid disruption, welfare spending has gradually been rising as a percentage of GDP and now tops 30%, a good five percentage points higher than at the reunification of the country 25 years ago.    

Chancellor Friedrich Merz has brought a stability that seemed to vanish when long-serving Angela Merkel stepped down, but he has caused consternation by accusing Germany of living beyond its means for years and reaching the point where it could no longer afford its welfare system. There will be a massive rise in poverty among the elderly and significant job losses unless the country can curb the runaway costs of its pensions system, he declared. Painful austerity measures were needed to ensure that younger Germans would enjoy future prosperity.

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The cost of public pensions has topped €400 billion a year and is rising remorselessly. Meanwhile, the finance ministry claims to have identified a cumulative €172 billion black hole in its spending plans over the next decade.

To a much lesser extent than in France, government is made more difficult by having a fragmented parliament. Merz’s conservative CDP rules in an uneasy coalition with its traditional political enemy, the left-wing SDP which finds welfare cuts anathema, but must pragmatically accept that the system is creaking.

Pensions are supposed to be fully financed through national insurance contributions by employers and employees but, with the average life expectancy creeping higher, the rising contributions are struggling to keep up with the costs. The taxpayer has had to fill a staggering €120 billion shortfall this year, about 3% of GDP and more than the entire defence budget, although that looks certain to rise in the near future as President Trump is demanding that Germany take the leadership in Nato’s European operations as Europe takes on greater responsibility for its own defence. The Nato target is for 3.5% of GDP to go on defence and another 1.5% to be allocated for wider security issues.

Yet attempts to cut back on other spending are strongly opposed. Proposals to raise the retirement age, currently 66 and due to be frozen at 67 in 2031, have produced widespread opposition, particularly among the mainly elderly voters backing the CPD and the SDP.

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Despite these political difficulties in the continent’s two largest economies, Europe has held up well amid the global turmoil of 2025. Christine Lagarde, president of the European Central Bank (ECB), was able to pronounce that the eurozone’s sovereign bond market was functioning in an orderly manner despite a jump in French borrowing costs at the height of the crisis. The ECB has been able to pursue an aggressive easing of monetary policy with interest rates brought down from 4% to 2% as inflation has eased towards the 2% target.

Europe remains a great place for UK investors. Share prices are not as inflated as they are in America and there is plenty of information available on companies and economies. Many larger companies have international operations that offer a hedge against setbacks in any one country and are often reasonably insulated from the quirks of President Trump’s trade policies.