The European Central Bank’s chief economist, Philip Lane, has warned that a prolonged escalation of Middle East tensions could push eurozone inflation above 4%. Speaking on Monday, Lane said the conflict could also trigger stagflation — a toxic mix of high inflation and stagnant growth — that would test the ECB’s policy framework and rattle asset markets.
Why 4% matters
Eurozone inflation has been gradually cooling from its double-digit peak in late 2022, but Lane’s projection of a return to 4% would undo much of that progress. The ECB has held interest rates at record highs since September, betting that its tightening cycle would be enough to bring inflation back to its 2% target. A sustained conflict in the Middle East, however, could revive supply-chain disruptions and energy-price spikes that the central bank cannot easily control.
The stagflation risk
Stagflation poses a particular problem for the ECB. Raising rates to fight inflation would worsen an economic slowdown, while cutting rates to support growth would risk fueling prices further. Lane did not specify which path the ECB might take, but his warning signals that the bank sees the situation as more serious than the temporary shocks of early 2023.
Asset markets, Lane said, would face headwinds from both higher inflation expectations and weaker growth prospects. Equities, bonds and currencies could all see increased volatility if the conflict drags on. The ECB has no direct control over geopolitical events, so investors will have to watch for further signals from the bank’s next monetary policy meeting in early June.
