The current tensions in the Middle East have raised familiar concerns in Europe about energy becoming a factor of macroeconomic vulnerability. With each escalation, oil prices rise, sovereign rates react, and financial markets adjust their expectations. In recent weeks, markets have even begun to anticipate two to three rate hikes by the European Central Bank (ECB) by the end of 2026, with the first hike as early as June.
These financial market expectations say a lot about investors’ mindset, but much less about the actual economic reality in Europe. In fact, this market reaction mainly reflects a geopolitical risk premium, a way for markets to protect themselves against uncertainty, rather than a real change in the inflation trend in the euro area.
An inflation not yet sustainable
The current energy shock, even if serious, has not yet shown the inflationary nature that some fear. This type of shock mainly affects price levels and not inflation rates. This distinction is crucial. This is exactly what the latest OECD and ECB forecasts show, partly taking into account the effects of the current conflict. These institutions anticipate inflation of 2.6% in 2026, slightly revised upwards, but mainly contained underlying inflation around 2.3%, before returning to 2% in 2027. Based on current data and trends, this is more of a price shock than a self-sustaining inflationary dynamic.
Recent speeches by some ECB members confirm this view. The ECB should be guided by economic data rather than market volatility. This is especially true if the current shock is more of a risk premium than an internal dynamic. What matters are the second-round effects, the transmission of an initial price increase (e.g. energy shock) to other components of inflation, thus fueling a more sustainable inflation. These effects are still remarkably contained. Medium-term inflation expectations have also not changed much.
The structural fragility of the European economy
Another critical element is the structural fragility of the European economy. After several years of successive shocks, the euro area is more indebted, more sensitive to interest rate variations, and more vulnerable to financial tensions.
Growth forecasts remain very modest. This week’s flash PMI figures confirm the picture of a fragile euro area. The composite index falls back into contraction in April, pulled down by a sharp weakening of services. The industry resists, but only thanks to precautionary stocks linked to geopolitical risks. Input costs are rising, but in a context of weakened demand. In such a scenario, a rate hike would have a faster and deeper impact, explaining the caution of some ECB members in responding swiftly to this shock.
Markets versus the economy
So why do markets anticipate so many rate hikes and especially a hike as early as June? Because they react differently from the real economy. Markets tend to overreact before returning to fundamentals. Today, every oil price hike is seen as a lasting signal, every geopolitical tension is extrapolated, every hesitation from the ECB is read as a sign of future closure. For a hike to occur as early as June, several conditions should be met. Namely, credible signs of second-round effects, thus a significant increase in underlying inflation. Even if this week’s PMI figures reignite the debate, recent economic data do not justify an immediate action by the ECB. The current baseline scenario is therefore one of a waiting ECB. However, an isolated hike remains plausible to maintain the institution’s credibility if inflation expectations were to rise.
