Eurosystem staff macroeconomic projections for the euro area, June 2026

The economic outlook for the euro area remains highly uncertain in the context of the war in the Middle East, the closure of the Strait of Hormuz and elevated oil price volatility. Some of the risks identified in the March 2026 ECB staff projections have started to materialise, with oil prices increasing further, supply chain pressures emerging, and markets now expecting the impact of the conflict to be more protracted. In the June 2026 Eurosystem staff baseline projections it is assumed that energy prices will decline relatively rapidly in the course of the next few quarters, in line with futures prices.^[1] However, the evolution of the conflict, together with its impact on energy prices, on the prices of some non-energy commodities and on economic activity, as well as the pass-through of the energy price shock to non-energy consumer prices, remain subject to considerable uncertainty. Therefore, in addition to the baseline, alternative scenarios have been prepared which assume varying degrees of intensity of the energy shock and its impact on the euro area economy.

Short-term indicators point to subdued economic growth in the near term, as higher energy prices and greater uncertainty weigh on domestic demand. In particular, as rising energy costs erode real disposable income and dampen consumer sentiment, household consumption growth – which was a key driver of growth in 2025 – is projected to slow considerably this year. Conditional on a relatively rapid resolution of the conflict and a related reduction in uncertainty, this weakness in private consumption growth is expected to be temporary. Over the medium term domestic demand should be bolstered by a recovery in real disposable income, owing to falling energy prices and a resilient labour market, and by rising government spending on infrastructure and defence, especially in Germany, complemented by investment related to artificial intelligence (AI). On the external side, export growth is expected to remain constrained by persistent competitiveness challenges, with euro area exporters experiencing further declines in their global market shares. The baseline projections foresee annual real GDP growth of 0.8% in 2026, 1.2% in 2027 and 1.5% in 2028. Compared with the March 2026 projections, GDP growth has been revised down by 0.1 percentage points for both 2026 and 2027, reflecting the stronger than previously expected impact of the war in the Middle East, while for 2028 it has been revised up by 0.1 percentage points as this impact is seen to unwind.

The baseline projections see headline inflation, as measured by the Harmonised Index of Consumer Prices (HICP), peaking at 3.4% in the third and fourth quarters of 2026 and remaining above 3.0% until early next year, driven by a surge in energy inflation as a result of the conflict in the Middle East. This mostly reflects a strong and immediate pass-through of higher crude oil prices to consumer fuel prices, amplified by additional pressures on prices of refined oil products. As most of the war’s impact on energy prices drops out of the year-on-year comparison, headline inflation is expected to fall sharply to 2.3% in the second quarter of 2027 and to hover around 2.0% thereafter. This profile for headline inflation masks diverging patterns across the main components. Decreases in energy commodity prices, as embedded in futures prices, as well as large base effects, imply that energy inflation would decline, turning negative in 2027, and would then tick up in 2028, owing to the introduction of the EU Emissions Trading System 2 (ETS2). By contrast, the energy shock is expected to feed through gradually to the non-energy components of the HICP, with inflation in these components continuing to increase up to the middle of 2027, partly offsetting the decline in inflation in the energy component, before moderating again in 2028. Food inflation is projected to peak at 3.7% in the second quarter of 2027 and then to ease in 2028. Similarly, HICP inflation excluding energy and food (HICPX) is projected to increase to a peak of 2.7% in early 2027 and then to moderate from the second quarter of the year. Indirect and second-round effects from the current energy shock are expected to be smaller than those seen in 2021-24, tempered by the weaker outlook for aggregate demand (which is expected to limit inflation compensation effects on wages), the past appreciation of the euro, and ongoing import penetration from China. At the same time, it is assumed that supply chain bottlenecks will not significantly amplify overall cost pressures. Overall, the baseline projections foresee HICP inflation picking up from 2.1% in 2025 to 3.0% in 2026, before declining to 2.3% in 2027 and then returning to target, at 2.0% in 2028. Compared with the March 2026 projections, the outlook for HICP inflation has been revised up by 0.4 percentage points for 2026 and 0.3 percentage points for 2027, largely on account of higher energy and food price assumptions, including stronger indirect effects on non-energy inflation. For 2028, it has been revised down by 0.1 percentage points, partly owing to a sharper than previously assumed decline in oil prices. HICPX inflation has been revised up by 0.2, 0.3 and 0.1 percentage points for 2026, 2027 and 2028 respectively, reflecting both higher services and non-energy industrial goods (NEIG) inflation in 2026-27 and higher NEIG inflation in 2028.

Alternative assumptions regarding the magnitude and persistence of the war in the Middle East and the energy price shock, their impact on the international environment and uncertainty, and propagation of the impact via indirect and second-round effects, would lead to markedly different macroeconomic outcomes. To illustrate this uncertainty, staff have prepared three alternative scenarios – an adverse scenario, a severe scenario and a milder scenario. These scenarios offer illustrative examples of alternative paths for energy commodity prices and their transmission to the euro area economy – they are not forecasts and staff do not assign any probabilities to them.

• The adverse scenario assumes a sharper and more persistent increase in energy prices than in the baseline. It also incorporates higher uncertainty and larger international spillovers, as well as stronger indirect and second-round effects on inflation. Relative to the baseline, it implies higher inflation in 2026-28 (Table 1). Conversely, GDP growth would be lower than in the baseline in 2026 and 2027 and the same as the baseline in 2028.
• The severe scenario assumes a stronger and more persistent energy price shock, greater uncertainty and a stronger reaction from wages and non-energy prices than in the adverse scenario. Relative to the baseline, it entails significantly and persistently higher headline inflation across the projection horizon, consistent with past experience of non-linearities in the face of a large energy price shock. GDP growth would slow considerably in 2026-27, before rebounding slightly faster in 2028 than foreseen in the baseline, reflecting the rise in income and in demand resulting from stronger responses from wages.
• Finally, in the milder scenario oil prices would normalise more rapidly than in the baseline, implying a faster moderation in inflation, which would fall below the 2% target in 2027 and 2028, while GDP growth would recover somewhat earlier and more robustly than in the baseline.

2.1 Real economy

The euro area economy has been relatively resilient in the face of the trade and uncertainty shocks that occurred during 2025 and in the first quarter of 2026, abstracting from volatility in Irish data. According to Eurostat’s flash estimate, real GDP rose by 0.1% in the first quarter of 2026.^[2] An adjusted measure of euro area GDP growth that uses “modified domestic demand” instead of GDP for Ireland rose by 0.2% in the same period, which was marginally less than foreseen in the March projections and down from the growth rate of 0.4% recorded in the fourth quarter of 2025 (Chart 1, panel a).^[3] As the war in the Middle East started towards the end of the first quarter of 2026, it did not have a significant negative impact on the growth outturn for that quarter.

The conflict in the Middle East is weighing on the short-term growth outlook, with energy price shocks and uncertainty proving stronger and more persistent than previously expected, further reducing purchasing power and confidence. Survey data available up to May point to a deterioration in growth momentum since the start of the war in the Middle East. The composite output Purchasing Managers’ Index (PMI) fell slightly to 48.6 in May, after a sharp deterioration in April. This was driven by a drop in the PMI for manufacturing output – although it remained above the threshold signalling growth, in part owing to stockbuilding in response to potential supply disruptions resulting from the conflict in the Middle East. Forward-looking PMI indicators improved somewhat from the troughs recorded in April, but suppliers’ delivery times lengthened further. Similarly, the European Commission’s Economic Sentiment Indicator fell sharply in April, mainly because of worsening sentiment among households and in the services sector, although it stabilised somewhat in May. These broadly negative signals from survey data for the short-term growth outlook are offset in part by an assumed strong increase in Irish GDP growth, which, however, is surrounded by considerable uncertainty (Chart 1, panel a). When modified domestic demand is used for Ireland, the slowdown is more pronounced, with euro area growth declining from 0.2% in the first quarter to 0.1% in the second and third quarters, before edging up to 0.2% in the fourth quarter. This implies downward revisions of 0.1 percentage points for the third and fourth quarters compared with the March projections and more subdued trade and consumption dynamics than previously expected.

Real GDP growth is projected to increase from 0.8% in 2026 to 1.2% in 2027 and 1.5% in 2028 as domestic demand recovers, conditional on the underlying assumptions embedded in energy price futures that the shock is temporary and that the contribution of net exports will turn positive in 2027 (Chart 2). Private consumption is projected to make the largest contribution to growth in the medium term, followed by robust investment dynamics. In terms of expenditure components:

• Household consumption is expected to be subdued in the short term, owing to losses in purchasing power and higher uncertainty, but should strengthen in the medium term. Consumer confidence has weakened noticeably since the start of the war in the Middle East, pointing to more cautious consumption behaviour. Looking ahead, private consumption growth is expected to strengthen, supported by a recovery in real wage growth – after the dip in 2026 owing to higher inflation – and still resilient labour markets. The household saving ratio is seen to be volatile in the short term as households attempt to smooth their consumption in the face of the energy shock. The smoothing of consumption is seen to be supported by fiscal measures related to energy prices in some countries, while precautionary motives are seen to temporarily exert some upward pressure on savings. The saving rate is expected to gradually decline over the medium term from still elevated levels (falling from 14.5% of disposable income in 2025 to 13.9% in 2028) as uncertainty recedes, precautionary motives wane and confidence improves towards its historical norm.
• Government consumption is expected to continue supporting medium-term growth. However, it is seen to contribute somewhat less over the projection horizon than in recent years. An expected slight slowdown in 2027 is mainly on account of the expiry of Next Generation EU (NGEU) funding in some countries and further budgetary savings in others (see also Box 3).
• Despite weakening somewhat in 2026, investment is expected to outpace GDP growth throughout the projection horizon as uncertainty related to the war in the Middle East recedes, digitalisation efforts intensify and defence and infrastructure spending increases. The conflict in the Middle East is expected to dampen private investment in the near term as a result of heightened uncertainty and lower demand. Business investment (excluding volatile Irish intellectual property product investment) is expected to start to recover from the second half of this year, despite tighter financing conditions, as uncertainty regarding energy prices, the conflict in the Middle East and supply chain bottlenecks is assumed to recede. This recovery should be further supported by improving demand and by digitalisation efforts in the face of rapid advances in AI. As public investment growth declines in 2027-28 following the expiry of the NGEU programme, business investment growth is expected to largely offset this decline, supported in part by spillovers to the private sector from increased defence and infrastructure spending, as well as gradually strengthening profits as demand normalises. While housing investment is expected to be marked by significant volatility in the first half of 2026, partly reflecting weather-related effects on the construction sector, the outlook has become more clouded as a result of rising supply-side pressures and weakening demand. Nevertheless, housing investment is projected to continue recovering over the projection horizon, supported by resilient labour markets and recovering real incomes, although higher mortgage rates continue to weigh on affordability.
• Exports are projected to remain subdued, reflecting persistent euro area competitiveness challenges that are being exacerbated by factors such as US tariffs and the past appreciation of the euro. In the short term the conflict in the Middle East is likely to further dampen export growth by weakening global activity. In addition, (i) a shift in demand away from the euro area’s core exports amid AI-driven global trade growth, (ii) the ongoing weak export price competitiveness compounded by the strength of the euro and (iii) the new tariffs (see Box 2), which are increasingly limiting exports to the United States, are anticipated to constrain export volumes over the medium run as well. As a result, the euro area’s share in global export markets is expected to remain subdued. Weighed down by high energy prices, imports are projected to be weak in the short term, before developing broadly in line with export dynamics over the medium term. AI and defence-related investment is expected to generate import demand in the medium run. Net exports are projected to provide a negative contribution to real GDP growth in 2026 and small positive contributions in 2027 and 2028.

Domestic demand is expected to be supported by the ongoing fiscal stimulus related to defence and infrastructure spending. The impact on growth from fiscal spending on defence and infrastructure, which is mostly accounted for by Germany and will exert the strongest impulse in 2026, is estimated to amount to 0.5 percentage points cumulatively over 2025-28.^[4] The energy support measures adopted by governments since the start of the war in the Middle East are predominantly temporary and are seen to have only a marginal impact on growth.

Compared with the March 2026 projections, real GDP growth has been revised down by 0.1 percentage points for both 2026 and 2027 and revised up by 0.1 percentage points for 2028 (Chart 3 and Table 2). The conflict in the Middle East has caused further increases in oil prices, geopolitical uncertainty and volatility in commodity and financial markets. Although GDP growth in the first quarter surprised to the downside, this was mainly due to volatility in Irish data, which has led to relatively large upward revisions to Irish growth in the short term. Aside from this volatility, the downward revision to within-year growth in 2026 mainly relates to a weaker outlook for consumption as the conflict in the Middle East is now assumed to last slightly longer, with a stronger impact on inflation and therefore on real incomes.^[5] Towards the end of the projection horizon, the reduction in energy commodity prices, a recovery in real disposable income and improving confidence imply slightly stronger growth in 2028. Given that in the March projections the growth outlook had already been revised down, the expected impact on growth stemming from the war is clearer when the June 2026 projections are compared with the December 2025 projections and amounts to a cumulative downward revision of 0.5 percentage points over 2026-27 and an upward revision of 0.1 percentage points for 2028.

The labour market is projected to remain resilient as firms are assumed to hoard labour in reaction to a temporary decline in economic growth owing to the conflict in the Middle East. In 2025 employment growth moderated following years of robust growth, and even prior to the outbreak of the war in the Middle East this rebalancing phase had already been expected to continue in 2026 and 2027. The June 2026 projections reflect expectations that firms will largely retain their workforce in the short term, despite the negative shock to output. As the fallout from the conflict is assumed to be transitory, the benefits firms might gain from layoffs are outweighed by the costs and challenges associated with rehiring later. Employment growth is projected to be slightly lower in 2026 than foreseen in the March projections but to demonstrate more resilience in 2027 and 2028, when it is projected to increase at an annual growth rate of around 0.5-0.6% (Chart 4, panel a). This reflects the dynamics in economic activity, including a more positive outlook for GDP growth in 2028. Nevertheless, employment growth remains below the level suggested by its historical relationship with output, as the labour market continues its rebalancing phase. This adjustment path gives rise to a small downward revision of 0.1 percentage points to labour productivity growth in 2027 compared with the March projections. The unemployment rate is expected to decline over the projection horizon, reaching 6.0% in 2028, which is a downward revision compared with the March projections (Chart 4, panel b). This revision is mostly driven by better than expected recent data for some countries and slightly more positive output and employment growth projected for 2028. Furthermore, structural forces, such as demographics, are expected to contribute to a lower unemployment rate.

2.2 Prices and costs

Headline HICP inflation rose significantly further in April 2026, with the effects of the war in the Middle East thus far mainly confined to energy prices.^[11] The increase in the headline rate to 3.0% in April, from 2.6% in March (1.9% in February), was driven by a surge in energy inflation due to both a month-on-month increase in energy prices and an upward base effect. Food inflation was unchanged, while HICPX inflation declined to 2.2% from 2.3% in March. Lower services inflation more than offset an increase in NEIG inflation amid rising manufacturing input costs and import prices. Overall, the effects of the conflict on non-energy consumer prices remained limited thus far.

Average headline inflation is projected to increase to 3.0% in 2026, mainly driven by higher energy prices, before declining to 2.0% in 2028 as the energy shock fades (Chart 5). Headline inflation is expected to rise to 3.4% in the third quarter of 2026 and to remain elevated until early 2027, driven mainly by the energy component. However, indirect effects from higher energy prices are also expected to materialise gradually, pushing up HICP inflation excluding energy to 2.7% on average in 2027, from 2.3% in early 2026.^[12] Indirect and second-round effects included in the baseline projections are expected to be milder than in the inflationary episode of 2021-24. This is mainly because the current total energy cost shock is smaller, with much more limited increases in wholesale gas and electricity prices (Chart 6), but also because of the current less inflationary environment, generally weaker aggregate demand and labour market conditions, and less widespread supply bottlenecks than in the 2021-24 episode. In early 2027 headline inflation is expected to decline because of expected lower energy commodity prices and because of large energy base effects as substantial increases in consumer energy prices this year fall out of the year-on-year comparison. It is therefore projected to fall sharply in the second quarter of 2027 to 2.3% and to stabilise at around 2.0% over the medium term, as the projected contribution from energy inflation is close to zero and the indirect and second-round effects of the energy shock are expected to be contained (Chart 5, panel b). The potential for stronger indirect and second-round effects as witnessed in the previous inflationary shock is considered in the scenario analysis focusing on the impact of the war in the Middle East (see Box 4 ).

Energy inflation is projected to peak at 12.5% in the third quarter of 2026, to fall sharply in 2027 owing to lower energy commodity prices and negative base effects, and to rise again in 2028 with the introduction of ETS2 (Chart 7). The profile of energy inflation in 2026 is highly uncertain and reflects assumptions for energy commodity prices, especially oil prices, and elevated refining and distribution margins for transport fuels. Increases in the prices of crude oil and refined oil products are being passed on fully and quickly to consumer liquid fuel prices, in line with historical regularities, and in a rather similar way across countries. In the case of gas and electricity, though, the pass-through from wholesale prices to consumer prices remains lagged and varies across countries. However, recent changes in retail energy markets suggest that retail prices – especially for gas – might react somewhat faster to changes in wholesale prices than in 2022. Given the current profile of the shock, which is concentrated on oil prices, it is expected that the rise in energy inflation will be mostly driven by fuel prices. At the same time, government measures have been announced and will cushion the impact of the energy price increases – these are concentrated in the second quarter and are expected to reduce energy inflation by around 0.6 percentage points on average in 2026. Given declining paths for oil and gas futures and large downward base effects early in 2027, energy inflation is projected to drop into negative territory in 2027. In 2028 the introduction of ETS2 is expected to push energy inflation up.^[13]

Food inflation is projected to increase in the short term on the back of the energy price shock, before receding later in the projection horizon towards 2% (Chart 8). Food inflation is expected to peak at 3.7% in the second quarter of 2027, reflecting increasing domestic food commodity prices related to higher energy and fertiliser costs, as well as other indirect effects of the energy price shock. These factors are expected to more than offset a dampening effect from moderating cocoa and coffee commodity prices and easing wage pressures. Food inflation is projected to decline as commodity prices stabilise and the indirect effects from higher energy prices fade.

HICPX inflation is expected to rise gradually then decline, averaging 2.5% in 2026 and 2027, then 2.2% in 2028 (Chart 9). In the short term HICPX inflation is projected to rise gradually and to peak in the first quarter of 2027 at 2.7%, driven mainly by a pronounced increase in NEIG inflation to 1.5%, while services inflation is expected to be broadly stable at around 3.3%. HICPX inflation is then projected to decline over the course of 2027, driven by a decline in services inflation. NEIG inflation is expected to strengthen further, peaking at 1.6% in the second quarter of 2027, before also declining. This HICPX profile reflects a gradual build-up of indirect effects from higher energy prices both domestically and globally, reflected in higher travel services prices, increasing import prices and hence higher manufacturing input costs, partly tempered by easing labour cost pressures, the past appreciation of the euro and import penetration from China. In 2028 both NEIG and services inflation rates are expected to moderate, with fading indirect effects and limited second-round effects via wages. HICPX inflation is projected to decline to 2.2% in 2028, with services inflation at 2.8% and NEIG inflation at 1.1%. The initially diverging profiles of services and NEIG inflation can be partly explained by the different timing and size of the energy shock pass-through in the two sectors (energy shocks typically have a faster and larger, albeit less persistent, impact on NEIG inflation) as well as by import prices playing a larger role for NEIG inflation.^[14]

Compared with the March 2026 projections, headline HICP inflation has been revised up by 0.4 percentage points for 2026 and 0.3 percentage points for 2027, while it has been revised down by 0.1 percentage points for 2028 (Chart 10, panel a). The upward revisions to headline inflation stem from revisions to all components and are concentrated in the second half of 2026 and the first half of 2027. The higher inflation profile is in line with recent upside surprises for unprocessed food and HICPX, higher energy and food commodity price assumptions and stronger expected effects of the war in the Middle East on the non-energy components. The downward revision of headline inflation for 2028 is consistent with a slightly stronger decline in oil price assumptions than in the March projections. The higher HICPX profile over the projection horizon reflects both higher services inflation and higher NEIG inflation in 2026 and 2027, with the NEIG component driving upward revisions in 2027-28 (Table 3). As a large part of the energy shock was already incorporated into the March projections, the revisions relative to the pre-conflict projections provide a more complete picture of the impact of the war. Compared with the December 2025 projections, headline inflation has been revised up substantially for 2026 and 2027 (by 1.1 percentage points and 0.5 percentage points respectively), reflecting an immediate effect on energy inflation and its delayed pass-through to non-energy components. However, headline inflation is unchanged for 2028, as a downward direct impact from the energy component broadly offsets an upward indirect impact from non-energy inflation (Chart 10, panel b). HICP energy inflation has been revised up compared with the December 2025 projections by 5.8 percentage points (cumulatively over 2026-28), while HICP inflation excluding energy has been revised up by 1.1 percentage points. The latter revision mainly relates to indirect effects and, to a lesser extent, second-round effects from the energy shock. As these effects may be underestimated by the standard projection models in the context of large shocks to energy prices, some limited upward adjustments have been included, based on staff judgement, to capture stronger pass-through effects from higher energy prices.

Nominal wage growth is expected to ease further throughout 2026, before rising slightly in 2027 and stabilising in the second half of the projection horizon. Growth in compensation per employee decreased in the fourth quarter of 2025, broadly in line with the March projections. It is expected to decline further over the course of 2026, reflecting weak near-term growth momentum, low confidence and high uncertainty, which also support the expectation of a slowdown in negotiated wage growth. Compensation per employee growth is expected to fall from 3.9% in 2025 to 3.2% in 2026, and to remain at that level in 2027 and 2028 as economic conditions strengthen (Chart 11, panel a). Real wage growth is projected to decline in 2026 and to turn negative in the second half of the year, before gradually converging towards productivity growth in 2028 (Chart 11, panel b). Compared with the March 2026 projections, compensation per employee growth has been revised down for 2026 in line with the signs of easing wage pressure from recent data outcomes and wage agreements, and revised up slightly for 2028. The current energy shock is expected to have a limited upward effect on wage growth, with weaker demand conditions and the less broad-based nature of the shock compared with the 2021-24 episode helping to contain second-round effects.

Growth in unit labour costs is projected to decline gradually over the projection horizon (Chart 11, panel b). The slowdown over the course of 2026 is explained by both declining wage growth and increasing productivity growth, whereas developments in the medium term stem from the productivity growth side. Growth in the GDP deflator is also expected to decline, on the back of lower growth in unit labour costs, partly compensated by a higher contribution from unit profits.

Import price growth is expected to increase sharply in the short term before declining in the second half of the projection horizon. In annual terms, the growth rate of the import deflator is projected to stand at 3.7% in 2026, up from 0.0% in 2025, driven by higher energy commodity price pressures, though dampened by the past appreciation of the euro and cheap imports from China. Import price growth is then projected to decline to 1.3% in 2028, reflecting an expected normalisation of global conditions.

The main uncertainties surrounding the June 2026 staff projections relate to the current war in the Middle East and its impact on energy prices and uncertainty, and the propagation to the economy.^[17] To illustrate these uncertainties, the projections are complemented, as in the March 2026 projections report, with a set of alternative scenarios. They offer illustrative examples of hypothetical alternative paths for energy commodity prices and their propagation to the euro area economy. The staff do not assign any probabilities to these scenarios – they serve rather to illustrate the key uncertainties regarding the impact of the conflict. While the baseline incorporates the energy commodity price paths embedded in the technical assumptions (see Box 2), the alternative scenarios differ in three main respects: the size of the energy shock, the degree of uncertainty and the strength of the transmission of the energy shock to non-energy prices (Table 4). Regarding the transmission, non-linearities and second-round effects on inflation can matter in the context of large shocks, which was an important lesson from the ECB’s 2025 assessment of the monetary policy strategy (see Box 4). Sensitivity analyses for the severe scenario examine the implications of two risks that are currently very prevalent, namely energy-supply rationing and jet fuel shortages. In line with the usual convention for scenario analyses in the staff projections, the scenarios assume that monetary and fiscal policy in the euro area are the same as in the baseline.^[18] For short-term and long-term interest rates, the projections are based on market expectations.

3.1 Key assumptions underlying the alternative scenarios

3.1.1 Energy commodity prices

The alternative scenarios use distributions derived from option-implied densities to define alternative paths for oil and wholesale gas prices. It is assumed that from the third quarter of 2026 oil and gas prices follow the 25th percentile of the market-based distributions in the milder scenario, the 75th percentile in the adverse scenario and the 95th percentile in the severe scenario (Chart 12).^[19] These percentiles provide a market-based assessment of the current risks surrounding energy prices and implicitly cover alternative evolutions of the war in the Middle East and its implications for energy supply disruptions.

• In the milder scenario, the oil price drops to USD 88 per barrel and gas prices to €41 per MWh in the third quarter of 2026 and they are around 15-20% below the baseline levels throughout the horizon. This projected path likely reflects investors’ expectations that the conflict could be resolved very swiftly, leading to a rapid normalisation of global oil and gas markets and a return of prices to their pre-war levels by the end of 2026.
• In the adverse scenario, the oil price increases to USD 122 per barrel and gas prices to €60 per MWh in the third quarter and they remain around 20-30% above the baseline levels throughout the horizon, likely reflecting market expectations of a more prolonged conflict than assumed in the baseline scenario.
• In the severe scenario, relative to the baseline, oil prices rise by around 60% and gas prices double, reaching USD 166 per barrel and €98 per MWh respectively in the third quarter. The shocks are also highly persistent, with deviations from the baseline still being of a similar magnitude at the end of the projection horizon. This persistence partly reflects greater uncertainty at longer horizons, which widens option-implied densities. It may also reflect market expectations of a prolonged conflict coupled with significant damage to regional oil and gas production infrastructure, keeping energy prices elevated over an extended period.

3.1.2 Uncertainty and its transmission to financing conditions

The adverse and severe scenarios assume that an escalation of the war in the Middle East would increase global uncertainty and trigger repricing in financial markets, though to varying degrees, which would weigh on private consumption, investment and trade. The VIX index is used in the scenarios as a proxy for global uncertainty. It is assumed to spike temporarily in the adverse scenario, and in the severe scenario the spike is assumed to be higher and more persistent. These assumptions are broadly consistent with episodes of comparable geopolitical tensions observed historically, including during Russia’s war against Ukraine and the conflict in the Middle East in October 2023 (Chart 13, panel a). Overall, uncertainty affects the economy in the scenarios in two ways: directly, via its impact on real GDP in the form of confidence shocks, and indirectly by transmission to financing conditions.

In the adverse scenario the temporary increase in uncertainty translates into a short-lived impact on the cost of euro area firms’ market-based debt and a relatively muted response of loan pricing, while in the severe scenario the effects are more pronounced given the assumed longer persistence of volatility (Chart 13, panel b).^[20] In the adverse scenario, corporate bond spreads increase by about 40 basis points for one quarter but quickly narrow again, as the model predicts a fast return to the low volatility state. In the severe scenario, spreads remain substantially above the baseline until 2027, fading out only towards the end of the projection horizon when the VIX index is in line with a low volatility state. Lending spreads (above the risk-free rate) show a limited and gradual increase in the adverse scenario, as banks would be able to buffer the impact of temporarily higher financial uncertainty, while the increase is more pronounced and protracted in the severe scenario. In the adverse scenario, corporate equity valuations fall by about 7 percentage points on average in the third and fourth quarters of 2026, then recover almost completely in 2027, whereas in the severe scenario they remain more than 10% below the baseline throughout 2027.

3.2 Macroeconomic implications

3.2.1 International environment

As direct trade links with the region affected by the conflict are relatively limited, the transmission of the shock to the global economy is expected to operate mainly through heightened uncertainty, as well as direct and indirect effects of higher energy and food prices (Chart 14). Heightened uncertainty is expected to lower global asset prices, tighten global financing conditions, and weaken global spending and trade. Higher oil and gas prices increase import costs, reduce real incomes and weigh most heavily on energy-importing economies. Rising energy costs also push up food prices, raising inflation and further dampening global demand.^[21]

In the adverse scenario, the world economy is hit by a moderate but persistent negative supply shock. The combination of the uncertainty, energy and food channels generates downward pressure on economic activity and upward pressure on inflation. Confidence weakens, import cost pressures rise and real incomes decline. In the United States, GDP growth is projected to be around 0.1 percentage points below the baseline in 2027, while inflation is projected to peak at around 0.6 percentage points above the baseline in 2027. For the global economy excluding the euro area, GDP growth is expected to be around 0.2 percentage points below the baseline in 2027, while inflation is projected to peak at about 0.9 percentage points above the baseline in 2027. For the euro area, the nominal effective exchange rate is expected to depreciate slightly before normalising thereafter, while foreign demand is expected to be about 0.9% below the baseline by 2028.

In the severe scenario, the negative supply shock is much larger and its effects persist for longer. The larger and more persistent energy shock generates a stronger inflation impulse, uncertainty rises more sharply, and larger food-related effects further erode purchasing power across economies. In the United States, GDP growth is expected to be about 0.5 percentage points below the baseline in 2027, while inflation is expected to peak at around 1.7 percentage points above the baseline in 2027. For the global economy excluding the euro area, GDP growth is expected to be around 1 percentage point below the baseline in 2027, while inflation is expected peak at about 2.6 percentage points above the baseline in 2027. For the euro area, the nominal effective exchange rate is expected to depreciate initially and then to normalise thereafter, while foreign demand is expected to be around 3% below the baseline by 2028.

In the milder scenario, these negative spillovers unwind more rapidly – with growth being higher and inflation being lower than in the global baseline projection. As energy prices decline again more quickly, the inflation impulse fades faster, uncertainty recedes, financing conditions normalise and foreign demand is stronger. As a result, global trade performs better and the euro area benefits from a more supportive external environment than in the baseline.

3.2.2 Euro area macroeconomic implications

The range of scenarios entails significant downside risks for euro area growth and upside risks for inflation (Table 6 and Chart 15). Both the adverse and the severe scenario imply progressively weaker GDP growth in the euro area (over 2026-27) and higher, more persistent inflation (over the full horizon) compared with the June baseline projections, with the severe scenario pointing to a pronounced deterioration in the outlook driven by sustained energy and uncertainty shocks. Under the milder scenario, economic activity would bounce back and inflation would moderate more quickly.

In the milder scenario, GDP growth would recover somewhat earlier and inflation would moderate faster than in the baseline. As the energy price rise unwinds more rapidly in this scenario than in the baseline assumptions, inflation would fall below the baseline level, undershooting the 2% target in 2027 and 2028. Lower energy prices would also benefit GDP growth, with real growth settling somewhat above the baseline, at 1.4% in 2027 and 1.6% in 2028.

In the adverse scenario, the shock would lead to a persistent upward shift in energy prices implying more prolonged inflationary pressures, while GDP growth would be weakened in the short term. Real GDP growth slows to below the baseline, at 0.7% in 2026 and 0.9% in 2027, but returns to 1.5% in 2028 as energy prices fall and uncertainty unwinds. HICP inflation rises in this scenario to 3.3% in 2026 and remains elevated at 3.0% in 2027, before reaching 2.3% in 2028. Core inflation peaks in 2027, at 2.7%, reflecting the gradual evolution of indirect and second-round effects across prices and wages, and falls to 2.3% in 2028.

The severe scenario implies a substantially more challenging macroeconomic environment, driven by stronger and more persistent commodity price shocks together with amplified indirect and second-round effects. Real GDP growth falls markedly to 0.5% in 2026, with negative growth in the second half of that year, and 0.4% in 2027, indicating prolonged weakness in activity. It bounces back to 1.6% in 2028. Headline inflation increases sharply, reaching 4.0% in 2026 and peaking at 5.3% in 2027, while core inflation rises substantially as higher energy prices increasingly feed through to domestic prices and wages.

The negative macroeconomic effects of the adverse scenario and the severe scenario initially stem mainly from higher energy costs and uncertainty, but over time arise increasingly through broader spillovers to trade, domestic demand and core inflation. Chart 16 shows that the deterioration in real GDP growth primarily reflects higher energy prices, increased uncertainty and weaker trade. In 2027 the slowdown becomes more pronounced as weaker global demand – in part linked to higher food and energy prices internationally – further weighs on euro area exports, while higher energy prices and tighter financing conditions place an additional drag on domestic demand. By 2028 GDP growth gradually normalises as energy price pressures fade and wages catch up to some extent after the initial decline in real incomes. As regards inflation, the main transmission channel operates through higher energy costs, which exert direct effects on energy inflation but also raise production costs for non-energy products. In the severe scenario, stronger indirect and second-round effects increasingly feed through to food and core inflation, leading to substantially more persistent HICP inflation. In the milder scenario, lower inflation than in the baseline, largely driven by lower energy prices, supports growth, which is further boosted by a more favourable external environment.

3.3 Sensitivity analyses of energy supply and jet fuel disruptions under the severe scenario

Sensitivity analyses have been conducted to explore the implications of two additional risk channels, both related to energy products, beyond those incorporated in the scenarios considered. They consist of the impact of energy supply rationing and jet fuel shortages. The sensitivities are presented only for the severe scenario, as these channels are most relevant when shocks are large and persistent and therefore primarily affect tail-risk outcomes. In line with the supply-shock nature of the analyses, real GDP growth would be lower and inflation would be higher in both cases.

3.3.1 Energy supply disruptions

Additional physical energy supply disruptions, as a result of raw and refined energy exports from the Gulf being cut off, might reduce the supply of crude petroleum gas and refined petroleum products in the euro area by 3% and would amplify the impact of the war in the Middle East beyond the price effects embedded in the scenarios. To assess this risk, a multi-country, multi-sector dynamic stochastic general equilibrium (DSGE) model with global production networks is used, enabling analysis of how disruptions to upstream energy inputs propagate across sectors and countries through input-output linkages.^[26] The impact on activity is significant, lowering euro area GDP growth by around 0.3 percentage points in 2026 and 2027 (Chart 17). Given the upstream nature of the shock, it also passes through firms’ marginal costs and downstream prices, raising euro area headline HICP inflation by around 0.1 percentage points in 2026, 0.4 percentage points in 2027 and 0.2 percentage points in 2028 on top of the effects triggered in the severe scenario.

3.3.2 Jet fuel shortages

In an event of extreme shortages, global air transport services could fall by 50%.^[27] According to a multi-country, multi-sector DSGE model with global production networks, such disruptions to air transport would lower euro area GDP growth by about 0.1 percentage points in 2027 and increase headline and core inflation by around 0.2 percentage points in 2027 and 2028 (Chart 17). The model assumes that replacing air transport with other transport methods would be difficult, especially for international travel and time-sensitive goods.

3.4 Caveats to the scenario analysis

These scenario analyses do not include any monetary or fiscal policy responses, which would mitigate the inflation impacts, as well as other channels that could affect the macroeconomic impact. As is the standard convention for scenario analyses in the staff projections, the scenarios assume monetary and fiscal policy are unchanged compared with the baseline. The significant increases in inflation, especially under the severe scenario, would likely be partly offset by tighter monetary policy or fiscal support measures which could lower consumer energy prices – as was seen in the 2022-24 episode of high inflation. Other channels not explicitly included in the analyses are possible positive impacts on tourism in euro area countries, which could benefit from tourism that would otherwise have flowed to the Middle East, and effects stemming from migration pressures related to a potential refugee crisis.

4.1 Alternative energy price paths

Alternative paths for energy commodity prices suggest significant upside risks for inflation, especially in the short term, and downside risks to growth. The staff projections are based on the technical assumptions outlined in Box 2. In this sensitivity analysis, risks are analysed using various percentiles from the option-implied neutral densities for both oil and gas prices.^[28] A constant price sensitivity analysis is also carried out for both oil and gas prices. This exercise differs from the Middle East conflict scenarios presented in Section 3 in that only energy commodity prices are affected while in the scenarios uncertainty also played a role in the way the macroeconomic effects were evaluated.^[29] The results are shown in Table 7.

4.2 Alternative exchange rate paths

Alternative paths for the exchange rate suggest the possibility of a further appreciation of the euro, especially over the medium term, and hence indicate some downside risks to growth and inflation. The technical assumptions for exchange rates in the baseline projections are held constant over the projection horizon. Alternative downside and upside paths are derived from the 25th and 75th percentiles of option-implied neutral densities for the USD/EUR exchange rate on 21 May 2026, which was tilted towards an appreciation of the euro (Chart 19). This is possibly because market participants’ expectations regarding monetary policy in the euro area relative to the United States, as well as expectations regarding a possible resolution to the war in the Middle East, are providing support to the euro. The impacts of the alternative paths are assessed using ECB and Eurosystem staff macroeconomic models. Table 8 shows the average impact on output growth and inflation across these models.