The European Central Bank's (ECB) latest survey of professional forecasters paints a grim picture of the eurozone's economic outlook, with a particular focus on the impact of the Middle East conflict on energy prices and inflation. The survey's findings have sparked a heated debate within the ECB's governing council, with policymakers divided over the appropriate policy response.
A Hawkish Outlook
The survey reveals a near-one-percentage-point upward revision to eurozone inflation expectations for 2026, rising to 2.7% from the previous projection of 1.8%. This sharp increase is primarily attributed to the surge in energy prices caused by the Middle East war. The ECB's professional forecasters predict that inflation will ease to 2.1% in 2027 and return to the target of 2% in 2028, suggesting a temporary nature to the current inflationary pressure.
However, the survey also highlights a concerning trend in core inflation, which excludes volatile energy and food prices. Core inflation measures have been revised upward, indicating a potential entrenchment of price pressures. This development raises questions about the sustainability of the ECB's longer-term inflation projections.
Growth and Unemployment Concerns
The survey's growth forecasts paint a picture of steady erosion. Real GDP growth expectations for 2026 have been cut to 1.0%, with the ECB attributing this downgrade to the energy price drag. The 2027 forecast is also revised downward to 1.3%, and this level is projected to persist through 2028 and 2030. Interestingly, unemployment expectations remain stable, with the jobless rate predicted to gradually ease to 6.1% by 2028, suggesting that the growth slowdown may not yet be translating into significant labor market deterioration.
Policy Divides and Uncertainty
The survey's findings have intensified divisions within the ECB's governing council. Slovak policymaker Peter Kazimir advocates for a June rate hike, citing the upward tilt in inflation outlook and the lack of improvement in the Iran war situation. He believes that rising energy costs are feeding into the broader economy, making a rate hike almost inevitable. However, Bank of France Governor Francois Villeroy de Galhau takes a more cautious approach, emphasizing the need for a critical mass of data on core inflation, wages, and expectations before committing to rate hikes.
The debate between Kazimir and Villeroy de Galhau reflects the uncertainty surrounding the ECB's policy decisions. The question of whether the inflation pickup is severe and broad enough to justify tightening monetary policy in a weakening growth environment remains unresolved. The burden of proof now lies with the doves, who must convince the council that patience is the wiser course while the situation clarifies.
Implications and Future Developments
The survey's findings have significant implications for the eurozone's financial markets and member states. A confirmed June rate hike would tighten financial conditions, potentially amplifying the stagflationary dynamic identified in the survey. Sovereign spreads in fiscally exposed member states are a particular concern, as the prospect of additional tightening collides with a weakening growth backdrop. The ECB's policymakers must carefully navigate these challenges to ensure a balanced and sustainable economic recovery.
