Europe Faces Prolonged Economic Shock from Middle East Conflict

The war that began when U.S. and Israeli forces attacked Iran, prompting Iran to close the Strait of Hormuz, has tightened energy supplies and lifted European prices. The cost surge has fed inflation, forced central banks to keep rates high, and weakened growth. The disruption follows the 2022 Russian invasion of Ukraine, which already pushed Europe into double-digit inflation and aggressive rate hikes. Mariano Cena, senior European economist at Barclays, says the outlook has shifted from an expected brief V-shaped dip to a prolonged U-shaped slowdown.

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Barclays cut its forecast for European growth this year to 0.7 percent, with a modest rise to 0.9 percent next year. Higher energy costs drain public budgets, limit investment, and keep inflation above target. The mix of elevated inflation and higher rates is expected to restrain consumer spending and keep growth below 1 percent.

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European policymakers responded to the 2022 gas shock by aggressively raising rates to curb price growth, which also constrained activity. Now, central banks signal willingness to keep rates high while inflation stays above target, reflecting a cautious stance to avoid renewed price pressures.

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Higher inflation erodes real household income, prompting consumers to curb discretionary spending. Public finances face larger energy outlays, reducing fiscal space for investment in infrastructure or innovation. The prolonged U-shaped slowdown could delay the recovery from the earlier gas shock, extending the period of subdued growth and elevated borrowing costs.

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• “A short-term shock is being extended in time,” — Mariano Cena, senior European economist, Barclays

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• “and Israeli forces attacked Iran, and Iran responded by closing off the Strait of Hormuz, the expectation was for what economists call a V-shaped impact, with a big but short drop in growth and a strong rebound, Mr.” — Mariano Cena, senior European economist, Barclays

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• “Now, it’s more U-shaped, where the economy is weaker for longer and the recovery is slower.” — Mariano Cena, senior European economist, Barclays

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• “The longer the disruption to energy supplies from the Persian Gulf goes on, the worse the effects get, he added.” — Mariano Cena, senior European economist, Barclays

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The source notes that higher inflation and interest rates are expected to continue into next year, limiting growth to under 1 percent. If the Strait of Hormuz stays closed, energy markets could face further price spikes, prompting policymakers to weigh additional tightening against the risk of deepening the slowdown. Cena warns that prolonged disruption to Persian Gulf energy supplies will worsen the economic effects.

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