Our economic outlook for the euro area

The escalation of tensions in the Middle East has led to a renewed surge in oil and natural gas prices, introducing a material downside risk to the euro area outlook. The macroeconomic consequences will hinge on how large and persistent the energy shock proves to be, but uncertainty has risen sharply and confidence indicators have begun to soften.

Under a scenario in which oil prices average $90–$100 per barrel and gas prices average €60/MWh for one to two quarters, we have reduced our 2026 GDP growth forecast by 0.4 percentage points to 0.8%. Most of the downgrade reflects the direct hit to real incomes and production costs from higher energy prices, with a smaller contribution from tighter financial conditions. Recent survey data are consistent with this narrative, with the flash composite Purchasing Managers’ Index falling close to stagnation and forward‑looking components weakening.

Higher energy prices also have clear implications for the inflation outlook. We have revised our 2026 headline inflation forecast upward to 2.5%, while lifting core inflation more modestly to 2.1%. The euro area remains particularly sensitive to energy shocks given its reliance on energy imports and the relatively large weight of energy in the inflation basket. Even so, inflation expectations remain broadly anchored, reflecting a more favorable starting point than during previous shocks.

The policy stance of the European Central Bank (ECB) is on a knife edge and firmly data dependent. We continue to expect policy rates to remain on hold, with the Governing Council attempting to look through an energy‑driven inflation shock. The case for holding rates is supported by the fact that the ECB comes into this shock in a relatively good place: Headline inflation has been close to target for the past two years, and inflation expectations remain well anchored. That said, risks are skewed toward hikes, particularly if energy prices rise further and/or the Middle East conflict proves prolonged.