A term from the past: due to war in the Middle East, Europe faces stagflation again
France's economy did not grow in the first quarter of this year, the conflict in the Middle East could have serious consequences for the country's budget. Photo: Chris Karidis / Unsplash.com
The war in the Middle East has undermined the eurozone economic recovery. GDP growth has slowed down and inflation has accelerated. ECB head Christine Lagarde suggested that the term "stagflation" should be a thing of the past. But analysts believe that the situation is too serious to ignore and are waiting for the tightening of the MPC.
At an inopportune moment
The eurozone's second-largest economy, France's, posted zero growth in the first quarter, the National Institute for Statistics and Economic Research (INSEE) reported on April 30. Domestic demand was weak: household consumption declined, as did corporate investment. Exports contracted significantly (minus 3.8% vs. 0.8% growth a quarter earlier), while the fall in imports accelerated (minus 1.7% after a 0.8% contraction in the fourth quarter). The only thing that supported GDP was the growth of companies' inventories. Two weeks ago, the French Central Bank forecasted economic growth of 0.3% in the first quarter.
The conflict in the Middle East could have "potentially very large consequences" for the country's budget, Finance Minister Roland Lescure told RTL radio station. He estimated them at €4-6 billion. In 2024-2025, France went through a political crisis, accompanied by the change of several governments, which could not agree on a budget with parliament. Only the current Prime Minister, Sébastien Lecornuil, managed to do so, passing the budget in parts in two stages - in December 2025 and early 2026.
Germany, the largest economy in the eurozone, in turn showed good growth in the first quarter - by 0.3%, while economists expected 0.2%. Chancellor Friedrich Merz promised that this year would be a "year of growth" thanks to the government's multi-billion dollar investments in infrastructure and defense sector. However, the German Economy Ministry has already halved its GDP forecast for the year to 0.5%.
"Rising energy prices hit Germany at the worst possible time," Christian Seving, CEO of Deutsche Bank, said recently(quoted by Bloomberg). - The economy has only just started to pick up."
Before it was first hit by the coronavirus pandemic and then by the energy crisis over Russia's invasion of Ukraine, Germany's economy grew at less than 1% in 2013 alone.
"We don't expect the war in Iran to push the German economy back into recession, but the risk of that is growing," said Geraldine Dany-Knedlik, an economist at the DIW Berlin research institute. - The extent of the slowdown will largely depend on how long global oil and gas supplies are constrained."
Donald Trump has instructed his aides to prepare for a lengthy blockade of Iran, the Wall Street Journal reported Tuesday, citing U.S. officials involved in recent White House meetings on the subject. But over the weekend, he announced "Project Freedom," which is designed to help ships stranded in the Strait of Hormuz get through. They will be assisted by destroyers, airplanes and 15,000 US fighters. Iran has already said it considers the US actions a violation of the ceasefire.
Other major eurozone economies, including Italy's and the Netherlands', also slowed growth.
Finland showed the highest GDP growth in the EU in quarterly terms with 0.9%, followed by Hungary with 0.8%. Estonia also accelerated significantly, whose GDP grew by 0.6% after falling by 0.1% a quarter earlier. Spain's economy, which had shown one of the highest growth rates in Europe in the previous few quarters, this time grew by 0.6%, less than a quarter earlier (0.8%).
Overall, eurozone GDP grew by just 0.1% in the first quarter compared to the previous quarter, when it added 0.2%, according to preliminary data from Eurostat. Analysts surveyed by Bloomberg had expected growth of 0.2%. The annualized rate was 0.8%, compared with 1.3% a quarter earlier.
Inflation, which had been hovering around the ECB's 2% target for a long time, accelerated to 2.6% in March and 3% in April, which was the highest annual growth rate since September 2023. The April jump was primarily due to a 10.9% rise in energy prices.
Europe is losing huge amounts of money because of the war in the Middle East, European Commission President Ursula von der Leyen told the European Parliament on April 29. "In just 60 days of conflict, our fossil fuel import costs have risen by more than €27 billion" without any increase in supplies, she said.
"The economy seemed absolutely poised for a gradual recovery this year," Carsten Brzeski, global director of macroeconomics at ING, commented to The Wall Street Journal. - The war in the Middle East has changed the situation. The negative impact on the eurozone will only intensify."
Inflationary impulse
Due to the slowing economy, accelerating inflation and uncertainty about the timing of the end of the Middle East conflict and the resumption of energy supplies, the ECB has found itself in a difficult situation. Market participants now expect that the bank, which on April 30 kept the rate at 2% for the seventh consecutive time, will raise the rate in June and may do so twice more before the end of the year, Bloomberg notes.
In March, the ECB already lowered its forecast for eurozone economic growth this year to 0.9%, while in December it expected 1.2%. But even this forecast may be too optimistic, Christine Lagarde warned on Thursday: "We are certainly deviating from the baseline scenario. What is extremely important is the impact that energy prices will have."
In a more pessimistic scenario, in which their supply problems persist until the end of the year, the ECB expects growth to slow to 0.4%.
However, Lagarde refused to talk about the threat of stagflation. According to her, "we do not apply this buzz term - stagflation - to the current situation, because we are sure that it is associated with the 70s" of the twentieth century, when inflation and unemployment were consistently high.
Unemployment in the eurozone was at an all-time low of 6.2% in March this year, while in the EU it was 6%.
Nevertheless, stagflationary pressures are building, Brzeski points out in his report. And if the war in the Middle East does not end soon, aggregate inflation will continue to accelerate, with price increases being passed on to transportation costs, food and other parts of the supply chain, he notes. In this situation, "the ECB is clearly moving to raise rates in June."
Although when assessing the next steps of the European regulator the current situation is often compared to 2022, it would be much more correct to compare it with 2011, Brzeski believes. Then the ECB raised the rate, responding to inflationary pressure due to rising energy prices, but underestimated the negative impact of the beginning of the debt crisis in the eurozone. As a result, the regulator soon returned the rate to its previous level.
The inflationary impetus from the war in the Middle East and the interruption of energy supplies is already strong enough for central banks - the ECB and the Bank of England - to simply ignore the shock, believes Paul Hollingsworth, an economist at BNP Paribas: "We think they will have to react to this situation over the coming quarters."
This article was AI-translated and verified by a human editor
