The eurozone’s fragile economic recovery is showing fresh signs of strain as rising energy costs linked to the conflict in the Middle East ripple through businesses and households, threatening to push the bloc back towards stagnation.
Recent business surveys indicate that private-sector activity contracted in May at the fastest pace in 18 months, highlighting the extent to which a renewed inflation shock is undermining demand across the single-currency area. The deterioration comes at a particularly awkward moment for policymakers, who only months ago believed they had largely contained the inflation crisis that followed Russia’s invasion of Ukraine.
Instead, Europe now finds itself confronting a familiar dilemma: slowing growth combined with rising prices.
The latest purchasing managers’ surveys suggest output declined for a second consecutive month, with both manufacturing and services sectors reporting weaker demand. New orders fell again, while export demand deteriorated at the sharpest pace seen this year, reflecting both subdued global trade conditions and growing uncertainty among consumers and businesses.
Germany and France, the eurozone’s two largest economies, remain at the centre of the slowdown. Although Spain and Italy have shown greater resilience, their modest expansion has been insufficient to offset weakness elsewhere in the bloc. The result is an increasingly uneven economic landscape that leaves the euro area vulnerable to further shocks.
What makes the situation particularly concerning is the resurgence of inflationary pressures. Input costs have risen at their fastest pace in more than three years, driven largely by higher energy prices following disruptions linked to the conflict in the Middle East. Companies are increasingly passing those costs on to customers, pushing selling-price inflation to levels that once again exceed the European Central Bank’s comfort zone.
Inflation across the eurozone climbed to 3.2 per cent in May, well above the ECB‘s 2 per cent target. Energy and services prices have been the primary drivers, reviving concerns that temporary price shocks could become embedded in the wider economy.
For ECB policymakers, the timing could hardly be worse.
Economic activity appears weak enough to justify monetary support, yet inflation remains sufficiently elevated to strengthen the case for tighter policy. Investors increasingly expect the central bank to raise interest rates at its June meeting, a move that would have seemed unlikely only a few months ago.
The challenge facing Frankfurt is that inflation today differs from the post-pandemic surge that dominated policy discussions earlier in the decade. While demand remains subdued, the latest price pressures are being driven largely by supply-side factors, particularly energy markets. That limits the effectiveness of conventional monetary tools while increasing the risk of policy mistakes.
Businesses are already responding to the weaker outlook. Employment growth has slowed sharply and job losses have accelerated to their fastest pace in more than five years, albeit from relatively low levels. Corporate executives report growing caution over investment plans as uncertainty surrounding energy supplies and geopolitical developments clouds the economic horizon.
The broader international backdrop offers little reassurance. The OECD warned this week that a prolonged conflict in the Middle East could significantly weaken global growth while pushing inflation higher across advanced economies. Europe, given its dependence on imported energy, remains particularly exposed to such risks.
The European Commission has already revised down its growth expectations for 2026, arguing that the renewed energy shock represents a significant setback for an economy that had been expected to enjoy a gradual recovery. Officials now foresee slower expansion and a more prolonged period of economic uncertainty than previously anticipated.
For businesses and consumers, the immediate concern is whether rising energy bills will further erode spending power. Consumer confidence remains fragile after years of inflation, and many households have only recently begun to recover from the previous cost-of-living crisis.
Europe’s policymakers had hoped that 2026 would mark a return to economic normality. Instead, the combination of geopolitical instability, weakening demand and resurgent inflation suggests the continent may be entering another period of uncomfortable economic adjustment.
The coming months will reveal whether this proves a temporary setback or the beginning of a more prolonged slowdown. For now, the warning lights across the eurozone economy are flashing once again.
