ECB Chief Economist: If Middle East Conflict Prolongs, Growth and Prices May Both Worsen

European Central Bank Chief Economist Philip Lane warns that if the Middle East conflict persists and regional oil and gas supplies continue to decline, the Eurozone could face a dual shock of soaring inflation and a sharp decline in output.

In an interview, Lane said, “From the perspective of direction, the surge in energy prices will exert upward pressure on inflation, especially in the short term.” He added that this development would also be “negative” for economic growth.

Last weekend, the US and Israel launched a “preemptive” military strike against Iran, which responded in kind. Several Middle Eastern countries, including the UAE, Qatar, Bahrain, and Iraq, were affected by the conflict.

On Monday, Qatar Energy issued a statement saying that operations at its facilities in Ras Laffan Industrial City and Mesaieed Industrial City had been halted due to military attacks on the sites.

The day before, an advisor to the Iranian Islamic Revolutionary Guard Corps commander stated that Iran would target all ships attempting to pass through the Strait of Hormuz. Eurasian natural gas prices surged rapidly, with Qatar’s “supply cutoff” prompting a more dramatic increase in gas prices.

Lane said the severity of the Middle East impact will depend on “the scope and duration of the conflict.” He added that if financial markets also reprice risks simultaneously, the effects could be further amplified. The ECB will “closely monitor the development of the situation.”

He mentioned that a scenario analysis published by the ECB in December 2023 indicated that if the Middle East conflict leads to a “sustained decline” in energy supplies and disrupts regional economic activity, it could trigger “significant inflation driven by energy and a sharp decline in output.”

In this model, the ECB assumes that one-third of oil and gas supplies transported through the Strait of Hormuz are disrupted. Economists estimate that in this scenario, with oil prices at around $80 per barrel, prices could rise by more than 50%, reaching about $130 per barrel. The Eurozone’s growth in the following year (2024) would decline by 0.6 percentage points, and inflation would rise by more than 0.8 percentage points.

Before this year’s conflict erupted, ECB economists predicted that from Q2 2023 to the end of 2027, annual inflation would be slightly below the ECB’s 2% target and would return to 2% in 2028.

Lane said he has not yet seen a reason to change the monetary policy stance: “I believe our current position is appropriate.”

He added that unless there is a significant and sustained shock from the Middle East, the Eurozone economy is “growing at a pace close to its potential,” and there are no obvious overheating risks.

“Growth in 2023 and 2024 is below potential, and there is still idle capacity, especially in manufacturing. We need a period of growth above potential to absorb this capacity.”

He also emphasized that, excluding volatile energy prices, inflation remains above the ECB’s medium-term 2% target, and last year’s wage increases were slightly higher than expected. “I don’t think this environment is one where we can afford to take inflation risks.”