EU Sees Risk of Stagflation Shock for Europe From Iran War

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(Bloomberg) — The European Union economy is at danger enduring low growth combined with high inflation because of the war in the Middle East, according to the bloc’s economy chief.

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“It is clear that, in any scenario, we are at real risk of a stagflationary shock,” Commissioner Valdis Dombrovskis told reporters on Friday after presenting estimates that would shave 0.4 percentage points off EU output this year in case of a short-lived war, and 0.6 percentage points in 2026 and 2027 compared with the previous forecast in autumn should the conflict be more protracted.

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A shorter conflict would also push up inflation by 1 percentage points this year, Dombrovskis said, while people familiar with the matter said the more severe scenario could add as much as 1.5 percentage points.

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Dombrovskis spoke after EU finance ministers held a call on Friday to assess the latest developments of the energy shock, which also was attended by Executive Director of the International Energy Agency Fatih Birol.

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“The outlook is clouded by profound uncertainty,” Dombrovskis said. 

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The lower output will represent a serious challenge for European economies. It would result in lower revenues just as governments face higher costs to replenish their energy reserves for next winter. Additionally, many are preparing support packages to help businesses and households under budget constrains.

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European capitals have already started to downgrade their forecasts due to the fallout from the war and the near-total closure of the Strait of Hormuz.

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German officials now see a risk that the nation’s economy will grow just 0.5%, down from the most recent projection of 1% if the Iran war drags on. Meanwhile, the Italian government is set to cut its growth forecast coming in April to as low as 0.5% for 2026 from a current 0.7%, although officials are still computing the data, Bloomberg previously reported.

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The European Commission “stands ready to work closely with member states to design policy measures at national level to mitigate impact of high energy prices,” Dombrovskis said, highlighting the need for any action to be targeted and temporary.

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He warned that “policy responses can have serious fiscal implications,” stressing that “our limited room for maneuver is more limited than before given the previous shocks and urgent need for additional defense spending.”

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The EU is keen to foster more coordination after similar measures in the wake of Russia’s invasion of Ukraine in 2022 proved not that targeted, nor temporary. European Central Bank President Christine Lagarde last week also urged governments not to go overboard on help for voters to weather the surge in energy prices.

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Dombrovskis had already told EU finance ministers during their previous meeting in March, in the early days of the war, that inflation rate could surpass 3% this year if the conflict causes Brent oil prices to remain around $100 per barrel and gas prices stay elevated for an extended period, Bloomberg previously reported.

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The economic fallout of the Iran war will be in focus when finance ministers gather in Washington next month during the International Monetary Fund’s spring meetings.

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The IMF is running scenarios on countries to gauge which economies could be in need of fresh financing if the Iran war drags on. Its Strategy, Policy and Review department has asked internally for analysis on areas from current account status to potential funding needs focusing on countries with financing programmes.

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(Updates with comments from Dombrovskis starting in first paragraph)

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