FXTRADING Financial Focus (Asia-Pacific 03/26)Eurozone Growth Slows as Energy Shock Clouds

S&P Global surveys showed that overall private sector activity in the Eurozone cooled notably in March, with the combined output of manufacturing and services falling to its lowest level in nearly ten months. Businesses widely reported that rising uncertainty is affecting orders and investment decisions, while the renewed increase in energy costs is making the operating environment more complex. Market sentiment has clearly weakened, and firms have become more cautious about the outlook for the coming months.

Although the European Central Bank chose to keep interest rates unchanged at last weeks policy meeting, maintaining the deposit rate at 2%, its latest projections already reflect a renewed build-up in price pressures. Under the baseline scenario, average inflation in the Eurozone is expected to reach 2.6% in 2026, before easing to around 2% in 2027 and edging slightly higher to 2.1% in 2028. This path suggests that the return of inflation to target will not be entirely smooth.

As tensions in the Middle East escalate rapidly, the Strait of Hormuz has at times come close to a full blockade, disrupting global oil and gas supply. Energy prices have risen sharply in a short period, and such cost pressures can easily transmit through transportation, industrial production, and services into the broader economy. Given Europes heavy reliance on energy imports, this external shock has a particularly pronounced impact on inflation expectations.

According to the central bank‘s scenario analysis, if the energy price shock proves more persistent, overall inflation in the Eurozone could rise to around 4% this year. In a more severe scenario, such as significant damage to energy infrastructure in the Gulf region, inflation could peak above 6% early next year. While this is not the baseline case, it is already enough to shift policymakers’ risk assessments.

At a policy conference in Frankfurt, ECB President Christine Lagarde addressed the dilemma facing policymakers. She noted that if price increases are only temporary, monetary policy may not need to respond aggressively. However, if inflation rises significantly above target, even for a relatively short period, a policy adjustment may still be necessary. Otherwise, it may be difficult for the public to understand why the central bank remains on hold while inflation clearly exceeds its objective.

Within the ECB, the focus is becoming more specific. Chief Economist Philip Lane highlighted that in the coming period, attention will center on firms pricing behavior and wage developments in the labor market. Whether companies continue to raise prices and whether wages for new hires increase significantly often provide earlier signals of persistent inflation than headline data alone. If both trends move higher simultaneously, inflation could prove more sticky than expected.

From FXTRADINGs perspective, the ECB is currently in a phase of continuous risk reassessment. Energy shocks, corporate pricing behavior, and labor cost dynamics could all lead to deviations in the inflation path. In the near term, policy is likely to remain data-dependent and cautious, but if price pressures are confirmed to be persistent, the policy stance may have to adjust. This uncertainty also suggests that the Eurozone macro environment will continue to be shaped by the interplay between energy and inflation in the period ahead.

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