Lagarde sounds the alarm: Uncertainty soars due to the Middle East – Inflation risk, growth trimmed

The assessment that the outlook for the Eurozone economy remains surrounded by significant uncertainty due to the war between the US and Iran, which is raging in the Middle East, was expressed by the President of the European Central Bank, Christine Lagarde, pointing out that there are still upside risks to inflation and downside risks to economic growth. As Lagarde mentioned, the baseline scenario of the ECB's new macroeconomic projections predicts that the Eurozone economy will grow at an average annual rate of 0.8% in 2026, 1.2% in 2027, and 1.5% in 2028. The ECB President emphasized that the new forecasts constitute a downward revision for the years 2026 and 2027 compared to previous estimates, a fact that reflects the ongoing challenges facing the European economy in an environment of increased geopolitical and economic uncertainty.

Outlook and price trends

Referring to the outlook for prices, Lagarde stressed that headline inflation is estimated to average 3.0% in 2026, 2.3% in 2027, and 2.0% in 2028, remaining on a path of de-escalation toward the ECB's medium-term target. However, as she pointed out, the risks to the inflation path continue to be upside, while growth prospects remain vulnerable to negative developments, a factor that maintains uncertainty as a key characteristic of the Eurozone's economic environment. It is noted that the ECB proceeded with its first interest rate hike since September 2024, due to the severe inflationary pressures manifesting in the economy. Specifically, the Governing Council decided to increase the three key ECB interest rates by 25 basis points. Consequently, the interest rates on the deposit facility, the main refinancing operations, and the marginal lending facility will increase to 2.25%, 2.40%, and 2.65% respectively, effective from June 17, 2026.

Why tightening...

Lagarde emphasized that the ECB decided to increase key interest rates by 25 basis points in order to ensure that inflation returns in a sustainable manner to the 2% target over the medium term. At the same time, she reiterated that future decisions will be taken meeting by meeting, based on incoming economic data and the evolution of inflationary pressures. Lagarde clarified that the ECB does not pre-commit to a specific rate path, as decisions will be made meeting by meeting based on economic data. The central banker warned that energy prices will keep inflation significantly above the 2% target through the first half of 2027, before it begins to de-escalate. She stated that the rise in energy prices is already affecting not only fuel but also the prices of food, goods, and services. As Lagarde said, the European economy is slowing down, with surveys showing weakening activity, mainly in the services sector.

On the other hand, the labor market remains resilient, with unemployment at 6.3%, close to historical lows, although the demand for workers is showing signs of slowing. Subsequently, she pointed out that higher energy expenditures and the deterioration of consumer confidence are expected to hit private investment in the short term. Finally, she called on Eurozone governments to maintain sound public finances and to proceed with reforms that will strengthen competitiveness and the growth potential of the economy, while placing particular emphasis on the need for the rapid adoption of the digital euro, arguing that it will strengthen the strategic autonomy, competitiveness, and integration of Europe's financial markets. She warned that any prolonged disruption in energy supply or global trade could lead to even higher inflation and weaker growth than currently projected.

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