Concerns are mounting in Europe over a potential energy crisis as military conflict between the U.S.-Israel and Iran intensifies. Financial markets are rapidly scaling back expectations for European Central Bank rate cuts amid fears that surging oil prices could reignite inflation.
"A spike in energy prices puts upward pressure on inflation in the short term," ECB Chief Economist Philip Lane said in an interview with the Financial Times on Thursday. "Such conflicts are likely to have a negative impact on economic activity as well."
Lane emphasized that core inflation, which excludes volatile energy prices, remains above the central bank's target. "This is not a time to take inflation risks," he said.
Consumer price inflation in the eurozone fell to 1.7% year-on-year in January, below the ECB's 2.0% target. However, core inflation registered 2.3%, indicating that price pressures have not fully subsided.
Europe experienced severe inflation following Russia's invasion of Ukraine in 2022, when supply disruptions sent natural gas prices soaring and drove up electricity and heating costs. Subsequent price stabilization was largely driven by falling international energy prices. Market tensions have resurfaced as Iran raises the possibility of blocking the Strait of Hormuz, a critical oil shipping route.
European nations, with the exception of oil producers like Norway, remain heavily dependent on energy imports and are particularly vulnerable to price swings. In a December 2023 scenario analysis, the ECB projected that a one-third disruption in oil and gas shipments through the Strait of Hormuz could send crude prices surging from $80 to $130 per barrel.
Rising oil prices are expected to weigh on both growth and inflation. Morgan Stanley estimates that a sustained $10-per-barrel increase in crude prices would add 0.4 percentage points to eurozone inflation while reducing economic growth by 0.15 percentage points.
These developments are already reshaping monetary policy expectations. According to Bloomberg, the probability of additional rate cuts this year has virtually disappeared from European financial markets, down from roughly 50% on April 27. Fears of renewed inflation have effectively halted the easing cycle.
The duration of the conflict will be decisive, analysts say. Holger Schmieding, chief economist at Germany's Berenberg Bank, predicted that price increases would not be prolonged. "President Trump will use every available means to curb the energy price surge, which would burden the domestic economy," he said.
Bloomberg noted that the next four weeks will determine whether Europe faces a full-blown crisis or merely a temporary setback in its recovery.