ECB member discusses euro area economic and inflation outlook amid Middle East crisis

Philip R. Lane, Member of the Executive Board of the European Central Bank, delivered remarks at an exchange of views on “The economic and fiscal implications in Europe of the Middle East crisis” at the European Parliament’s Committee on Economic and Monetary Affairs.

He highlighted that the situation remains fragile with risks of escalation. The impact on medium-term inflation and growth depends on energy price shocks and their effects.

The euro area economy contracted by 0.2% in the first quarter, mainly due to Ireland, with other countries showing growth supported by domestic demand and exports. The war has weighed on activity, especially in services, with new orders stagnating in May.

The labour market remains resilient, with an unemployment rate of 6.3% in April. Firms are holding on to workers despite weaker conditions, but demand is cooling. Domestic demand is now expected to be weaker, with confidence declining and higher energy costs reducing real incomes.

Household balance sheets remain solid, supporting consumption. Investment is expected to decline short-term due to higher energy costs and lower confidence but may be supported by digital investments and increased public spending on defense and infrastructure.

The June Eurosystem projections forecast real GDP growth of 0.8% in 2026, 1.2% in 2027, and 1.5% in 2028.

Inflation increased to 3.2% in May, with energy prices remaining high despite a monthly decline. Non-energy inflation rose to 2.4%, with food inflation decreasing and core inflation increasing. Wage growth remains steady, with negotiated wages growing at 2.5% in Q1 2026.

Indicators suggest inflationary pressures will persist, driven by energy prices and supply chain disruptions. Inflation is expected to stay above target into the first half of 2027, with projections of 3.0% in 2026, 2.3% in 2027, and 2.0% in 2028.

Short-term inflation expectations remain above pre-war levels, but longer-term expectations are around 2%, supporting medium-term stabilization.

Risks to growth are to the downside, while inflation risks are to the upside. Severe scenarios could keep inflation above target and reduce growth; milder scenarios suggest inflation may fall below target in the medium term.

The ECB responded with a 25 basis point rate increase in June, citing signs of energy shock affecting inflation and the need for a measured response amid ongoing uncertainty.

The Governing Council will continue to monitor incoming data and adopt a data-dependent approach, without pre-committing to a specific rate path, to ensure inflation stabilizes at 2% in the medium term.

In conclusion, the Middle East crisis has increased uncertainty, affecting inflation and growth. Despite challenges, the labour market remains resilient, and public investment is expected to support future growth. The ECB remains committed to its inflation target and will adjust policies as needed based on incoming data.