Will Europe slide into a recession?

The turmoil in commodity markets, driven by events in the Middle East, is not great news for the global economy. But the impact will not be the same everywhere. Countries that rely heavily on imports of oil, gas, fertilizers, etc., are likely to feel it the most. That includes not only parts of Asia, but also the Eurozone.

According to ECB estimates, a 14.2% increase in oil prices and a 20% jump in gas prices could add about 0.5 percentage points to inflation. In a more severe supply shock, inflation could exceed forecasts by over 0.8 points, while eurozone growth next year might come in 0.6 points below expectations.

Goldman Sachs, in its base case, expects inflation to rise by around 0.3 points, with growth easing by 0.2 points. In a worst-case scenario, though, inflation could surge by as much as 3.6 points by the end of 2026 if the conflict drags on.

Markets are not standing aside either.

Not long ago, investors expected ECB rate cuts, but now there is a 33% chance of a 25-basis-point hike by December 2026 and over 90% chance that rates will stay at 2% through year-end, while short-term yields rising faster than long-term ones signal stagflation worries, and the weaker EUR/USD on a stronger DXY reflects lower confidence in the Eurozone.

On the corporate side, pressure is mounting as well. Even before the events in the Middle East, companies with liquidity issues, weak balance sheets, and low profitability had already been on the rise. The most vulnerable sectors are those linked to consumer demand and global trade, including fashion, retail, manufacturing, chemicals, automotive, business services, and construction. Geopolitical uncertainty is making restructuring more urgent and recovery harder.

The challenge now is that, back in 2022, EU governments were able to inject billions to cushion the impact of energy shocks. This time, their room to act is much more limited. High levels of public debt, especially in countries like the UK and France, make large-scale support unlikely.

Another risk for the Eurozone is rising migration pressure, which could add to both economic and political instability.

No surprise then that European markets are reacting much more sharply to tensions in the Middle East than in the US.