EU Forecasts Stagflation as Iran Conflict Spikes Energy Prices

The European Commission downgraded its 2026 growth forecast for the eurozone to 0.9%, down from 1.2%, citing a stagflationary shock caused by conflict in the Middle East. The economic downturn follows the closure of the Strait of Hormuz—a critical oil transit point—after Iran retaliated against US-Israeli strikes with drone and speedboat attacks. This disruption pushed oil prices above $100 per barrel and drove eurozone inflation to 3% in April 2026, the highest level since September 2023.

Economic activity contracted sharply in May, with the Composite PMI hitting a 31-month low of 47.5. France saw the most severe decline, with its PMI plunging to 43.5, while Germany's growth forecast was reduced to between 0.5% and 0.6%. The European Central Bank now faces a policy dilemma: fighting inflation that exceeds its 2% target while economic growth deteriorates. Officials indicated that interest rate hikes may be necessary at the June 11 meeting to anchor expectations.

EU officials and finance ministers met in Cyprus to discuss the fiscal response. While Italy urged the Commission to relax deficit rules to fund energy security, the Commission and other member states advocated for temporary, targeted measures to avoid fueling fossil fuel demand. International Monetary Fund Managing Director Kristalina Georgieva warned that the conflict would permanently scar the global economy through infrastructure damage and supply disruptions.