By Ed Frankl
The European Union cut its forecasts for eurozone economic growth and raised its expectations for inflation this year as the energy-price shock from the conflict in the Middle East ripples through the economy.
The eurozone economy had previously been set to expand at a moderate pace in 2026 after inflation cooled below the European Central Bank's 2% target, but that outlook was upended by the start of the war in Iran.
The European Commission in its twice-yearly report said Thursday that it now expects eurozone growth in 2026 at 0.9%, from 1.2% it forecast in November, and trimmed its prediction for 2027 gross domestic product growth to 1.2% from 1.4%.
Inflation in the 21-nation currency area is set to rise to 3.0% from 2.1% last year, also higher than the 1.9% it anticipated in November. Price growth in 2027 is seen at 2.3%, higher than the 2.0% it previously predicted.
As a net energy importer, the eurozone is highly exposed to the energy shock caused by the closure of the Strait of Hormuz. Between the first U.S.-Israeli strikes on Iran on Feb. 28 and the cut-off date for the assumptions made under the forecast on April 29, gas prices had increased by 50% and crude oil prices by 65%. While commodity prices are expected to decline in 2027, they could remain around 20% above prewar levels, the commission said.
"The conflict materially changed this picture, delivering one of the most significant global energy supply disruptions in recent history," the commission said.
Its forecast for growth in Germany, particularly susceptible to high energy costs due to its large manufacturing sector, was halved to 0.6% from 1.2%. French and Italian activity expansion was trimmed, though Spanish growth received a small upgrade.
Consumer confidence edged up in May, data also published Thursday showed, but has dropped to multiyear lows in recent months as the spike in energy costs drives up household utility bills and leads to fears of accelerating inflation and job losses. Weaker external demand is also weighing on export growth as the energy shock reverberates globally.
Investors expect the ECB to raise its key interest rate when it meets next month, and make either one or two further hikes before the end of the year.
However, consumption is expected to remain the main driver of growth, the commission said. Having diversified its energy supply, the economy is in a better place to absorb the shock than the last major energy blow after Russia's full-scale invasion of Ukraine in 2022, it noted.
The economic situation is set to "improve slightly" if tensions on energy markets ease, though the window for such normalization of prices is "narrowing", said European Commissioner for the Economy, Valdis Dombrovskis.
Owing to an unusually high level of uncertainty, the commission offered an alternative scenario in which commodity prices would rise above current market expectations should the war drag on. In that case, growth would be roughly halved compared to the baseline scenario and inflation would rise to 3.4% in 2027, Dombrovskis said.
Write to Ed Frankl at edward.frankl@wsj.com
(END) Dow Jones Newswires
05-21-26 1031ET
