A bottleneck in the Middle East is currently determining the fate of the European economy. Ever since the Strait of Hormuz has been on everyone’s lips, energy prices have been skyrocketing: Brent crude is trading at around $90 per barrel, and European natural gas prices have risen by 60 percent.
This exogenous shock has hit monetary policymakers at the worst possible time and forced them to pause: At the ECB meeting on March 19, the deposit rate remained unchanged at 2.0 percent – for the sixth consecutive time. The uncertainty is too great to act now.
As recently as February, the ECB celebrated a minor victory: inflation had fallen to 1.9 percent, and the economy was showing slight growth. But that success is already a thing of the past. The blockade of the Strait of Hormuz is projected to cause a potential jump in inflation to around 2.4 percent by 2026, while simultaneously dampening growth. Accordingly, we do not expect inflation to ease until 2027.
The key factor will be how long energy prices remain elevated. Services inflation remains at 3.4 percent, and labor costs rose by 3.1 percent in the fourth quarter. A prolonged energy shock could intensify this dynamic and trigger second-round effects. At the same time, the economy faces the threat of a significant slowdown: An ECB scenario from December 2023 already showed that a partial blockade of the Strait of Hormuz would reduce growth by 0.7 percentage points. In the event of a complete blockade with rationing, a recession would even be conceivable.
Markets are now pricing in 1.8 interest rate hikes by the end of 2026 – an expectation that fails to reflect economic reality. While some Governing Council members, such as Peter Kažimír, have hinted that rate hikes are “closer than many think,” the majority emphasizes caution. A prolonged energy shock would not overheat the eurozone but rather stifle it. The risks of recession are significant: a full-blown Hormus scenario could depress growth by two percentage points or more. In such an environment, interest rate hikes would be counterproductive. The ECB is expected to present alternative scenarios that highlight these downside risks.
ECB President Christine Lagarde and the entire ECB believe they are in a good “starting position.” However, they must navigate the most difficult balancing act since the 2022 energy crisis. One wrong move, and temporary inflation spikes could turn into a recession. The coming weeks will show whether the situation in the Middle East eases – or whether the ECB will be faced with significantly more difficult decisions.
Note: This text was translated using AI and may contain translation errors. The German version of the text is authoritative.