The growth of economic activity in the eurozone is set to slow down this year, while inflation is expected to rise, leading the European Central Bank (ECB) to raise its interest rates, even if the disruptions caused by the war in Iran ease by mid-year, the International Monetary Fund (IMF) said on Tuesday.
The monetary bloc, which imports the majority of its energy, is particularly vulnerable to the surge in energy costs, especially as the conflict in Ukraine has already strained the bloc’s access to essential resources.
In its updated outlook on the global economy, the IMF warned that “eurozone growth will slow to 1.1% this year from 1.4% in 2025. This forecast is lower than the 1.3% projected in January.”
“The impact of the war will add to the lingering effects of rising energy prices since the invasion of Ukraine by Russia, weighing on the manufacturing sector, with additional pressure due to the real appreciation of the euro against currencies of countries exporting similar products,” the IMF explained.
However, the IMF’s outlook is more optimistic than the ECB, which last month projected growth of 0.9% this year.
The projected increase in defense spending will partly offset the expected slowdown, but since the growth of these expenses is relatively slow, the positive effect is expected to materialize later, the IMF stated.
Inflation, on the other hand, is expected to rise to 2.6% in 2026, up from 2.1% last year, according to the IMF’s reference scenario, which assumes that the Middle East conflict will be limited in duration, intensity, and scope, allowing disruptions to ease by mid-2026.
In response to this increased inflation, the ECB’s interest rate, currently fixed at 2%, is expected to increase by 50 basis points during the year, the IMF indicated.
Investors are already factoring in a rate hike by June, assuming that the ECB will want to send an early signal that it will not tolerate inflation spreading beyond the energy sector and generating a price spiral through second-round effects.
Like the ECB, the IMF has also devised “adverse” and “severe” scenarios that suggest more significant repercussions of the Middle East conflict on global growth and inflation.
(Reporting by Balazs Koranyi; Editing by Blandine Henault)
