The current tensions in the Middle East have reignited a familiar concern in Europe, regarding energy becoming a factor of macroeconomic vulnerability. With each escalation, oil prices tighten, sovereign rates react, and financial markets adjust their expectations. In recent weeks, markets have even begun to factor in two to three rate hikes by the European Central Bank (ECB) by the end of 2026, with the first hike expected as early as June.
These financial market expectations reveal a lot about investor sentiment, but much less about the actual economic reality in Europe. In fact, market reactions mostly reflect a geopolitical risk premium, a way for markets to protect themselves against uncertainty, rather than a true change in inflation trends in the eurozone.
An inflation not yet sustainable
The current energy shock, serious as it may be, has not yet taken on the inflationary nature that some fear. This type of shock primarily affects price levels, not inflation rates. This distinction is essential. This is exactly what the latest forecasts from the OECD and the ECB show, which partially incorporate the effects of the current conflict. These institutions anticipate inflation of 2.6% in 2026, slightly revised upwards, but mainly contained core 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 also support 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 inflation components, fueling a more sustainable inflation. These effects remain remarkably contained. Medium-term inflation expectations have also not changed much.
The structural fragility of the European economy
Another crucial element is the structural fragility of the European economy. After several years of successive shocks, the eurozone 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 this view of a fragile eurozone. The composite index fell back into contraction territory in April, dragged down by a sharp decline in services. The industry is holding up, but relies on precautionary stock levels due to geopolitical risks. Input costs are rising, but in a context of weakened demand. In such a scenario, a rate hike would have a quicker and deeper impact, explaining the caution of some ECB members to react swiftly to this shock.
Markets vs. the economy
So why are markets anticipating so many rate hikes and especially one as early as June? Because they react differently from the real economy. Markets tend to overreact before returning to fundamentals. Today, every oil price increase is seen as a lasting signal, every geopolitical tension is extrapolated, every ECB hesitation is seen as a sign of future firmness. For a hike to occur as early as June, several conditions would need to be met. In particular, credible signs of second-round effects, meaning a significant increase in core inflation. Even though this week’s PMI figures reignite the debate, recent economic data do not justify immediate action by the ECB. The base scenario currently remains one of a waiting ECB. However, an isolated hike remains plausible to preserve the institution’s credibility if inflation expectations were to tighten up.
