France's unemployment rate unexpectedly rose to its highest level in five years, providing further evidence that the Eurozone's second-largest economy was already in a weak state when the Middle East conflict erupted, mirroring the broader economic challenges across the currency bloc. Data from the French national statistics office showed the unemployment rate climbed to 8.1% in the first quarter, surpassing 8% for the first time since 2021, as joblessness increased across all age groups. Economists had expected a slight decrease to 7.8% from 7.9% at the end of last year.
French central bank governor François Villeroy de Galhau stated on Wednesday, "The slight rise in unemployment figures reflects an economic slowdown." However, he emphasized the importance of remembering "France's long-term economic progress." He noted, "During the previous economic slowdown after 2012, the unemployment rate in France was above 10%; it is now around 8%. This is clearly not welcome news. But since 2010, France's economy has created a net increase of over 4 million jobs."
French Budget Minister David Amiel also commented in an interview, stating this data "reminds us that we must continue to advance this top-priority work." Despite the government successfully navigating a budget crisis in February and avoiding renewed political turmoil, the deteriorating labor market data released Wednesday drew significant attention.
Data released at the end of April had already shown that, dragged down by weak trade and insufficient domestic demand, the French economy failed to grow in the first quarter. This fell short of economists' average expectation of 0.2% growth and the French central bank's forecast of 0.3% growth. The data indicated the French economy was constrained by a 0.1% drop in consumer spending and a 0.7% decline in household investment in Q1. Business investment also fell by 0.2% in the first quarter after stalling at the end of 2025. A sharp 3.8% drop in exports resulted in a 0.7% negative contribution from net trade to GDP. However, inventory accumulation offset this drag, providing a 0.8% boost.
Xavier Debren, chief economist at the French central bank, stated, "The resilience of the French economy is beginning to be tested." "Since the beginning of the year, we have consistently emphasized the surprising resilience shown by the French economy. Now, we are seeing the first signs of the shock starting to materialize."
Some market analysts believe the weak performance of the French economy in Q1 has undermined the government's annual growth target of 0.9%. The economy would need to maintain sustained and stable growth over the next three quarters to have a chance of reaching this goal. Economists predict that a blockade of the Strait of Hormuz could reduce France's economic growth this year by 0.3 percentage points.
A business survey released by the French central bank on Tuesday suggested the Middle East conflict has begun to drag on economic activity and intensify inflationary pressures. The survey of 8,500 business executives showed activity in industry and construction slowed in April and could decline this month. In the services sector, companies reported stagnant business and anticipated a contraction in May. Furthermore, the proportion of companies raising prices across sectors is accelerating, with 13% of industrial firms reporting supply difficulties.
Data also released on Wednesday showed France's final April CPI rose 2.2% year-on-year, up from 1.7% in March. The harmonized CPI for April rose 2.5% year-on-year, the highest level since July 2024, up from 2% in March. Analysis widely suggests this round of inflation resurgence in France is primarily influenced by the recent sharp rise in international energy prices. In April, French energy prices surged 14.2% year-on-year, significantly higher than the previous month, with notable increases in gasoline and diesel prices. Besides energy, service prices also pushed inflation higher, particularly in transportation and accommodation. Meanwhile, food price increases slowed slightly, while tobacco and industrial product prices remained generally stable or saw slight declines.
The Eurozone economy is mired in a "stagflation" quagmire, leaving the European Central Bank navigating a narrowing policy path—struggling to strike a difficult balance between "raising rates to curb inflation or cutting rates to stabilize growth."
Inflationary pressures in the Eurozone are worsening. The Eurozone's inflation rate jumped to 3% in April, the fastest pace since autumn 2023, up from 2.6% in March. Data shows Eurozone energy prices rose 10.9% year-on-year in April, up from 5.1% in March. Food, alcohol, and tobacco prices increased by 2.5%, service prices by 3.0%, and non-energy industrial goods prices by 0.8%.
An economist survey conducted from May 4 to 7 indicated that, influenced by the Middle East conflict pushing up energy prices, Eurozone inflation in 2026 is expected to accelerate to 2.9% from the 2.8% forecast in the previous survey. The ECB's own assessment has also significantly raised its 2026 inflation forecast from 1.9% to 2.6%. Analysts expect inflation will not return to the ECB's 2% target until 2028.
Simultaneously, the Eurozone's growth prospects are concerning. First-quarter GDP grew by only 0.1%, below expectations. Analysts have revised down their 2026 Eurozone growth forecast from 0.9% to 0.8%, with subsequent years projected to grow by 1.3% and 1.5%, respectively. The European economy is currently affected by multiple adverse factors, such as U.S. tariff hikes and weak external demand. Rising energy prices will impact Europe's manufacturing transformation, placing significant pressure on energy-intensive industries. Analysts suggest that if the energy crisis persists, inflation could spread to multiple sectors, weakening Europe's growth momentum and plunging the region into a stagflation scenario of stagnant growth and high inflation.
Last month, the ECB announced it would keep the deposit facility rate unchanged at 2%, aligning with market expectations. The ECB did not provide guidance on future decisions, reiterating it would decide on a meeting-by-meeting basis based on incoming information. The ECB Governing Council stated in its announcement, "Upside risks to inflation and downside risks to growth have intensified. The Governing Council remains in a good position to address the current uncertainty."
Following the rate decision, ECB President Christine Lagarde stated in a press conference that although policymakers had discussed the option of a rate hike and would reassess the need for policy tightening at the June meeting, the current Eurozone economic situation should not be labeled as stagflation, emphasizing it is "completely different" from the 1970s. Lagarde noted the decision was made with still-incomplete information, but the Council not only unanimously agreed to keep rates steady but also engaged in a "thorough and comprehensive" discussion about a potential hike. She stated the next six weeks would be a crucial window for assessing the economic situation to make a decision based on more complete data at the June meeting.
Currently, economists expect the ECB to hike rates twice this year—by 25 basis points each in June and September—bringing expectations closer to market views of at least two moves this year.
There is a clear divergence within the ECB regarding the monetary policy outlook. Earlier this month, ECB Governing Council member and Slovak central bank governor Peter Kažimír stated the ECB would most likely need to raise interest rates at its June policy meeting. Kažimír said that while central bankers have not pre-committed to any fixed path and need more data to assess the impact of the Middle East conflict, "our stance remains firm." He wrote in a column, "On this basis, a monetary policy tightening in June is almost inevitable. We must prepare for the widespread and persistent price increases and significantly slower growth in the Eurozone, which (a June hike) is becoming increasingly likely."
ECB Governing Council member and German central bank president Joachim Nagel said this week that, affected by the Middle East conflict, the likelihood of the ECB needing to raise borrowing costs is increasing. Nagel stated, "I still hold a glimmer of hope for a significant de-escalation in the Middle East—but we cannot ignore high energy prices. Unless there is a fundamental change in the inflation situation, a rate hike is becoming increasingly likely." He also warned, "We may still face considerable inflationary pressure in the future." Nagel acknowledged that Eurozone economic weakness could influence next month's decision. He said, "No one likes raising interest rates when growth is under significant pressure. But our mandate is to maintain price stability. In the long run, it benefits everyone if we clearly signal we take the inflation target seriously and keep medium-term inflation around 2%. We will fulfill our mandate—no excuses."
However, other policymakers hold a more cautious stance. ECB Governing Council member and Lithuanian central bank governor Gediminas Šimkus stated, "Clearly, we are discussing the possibility of a rate hike in June. But whether a decision is actually made will depend on the specific circumstances and data." He added that if the Middle East conflict is resolved, "then that would be a factor allowing us to consider making a different decision."
Villeroy de Galhau stated that if inflation spreads beyond the rise in oil prices, the ECB must remain cautious while also being prepared to act on interest rates. He also said that before any monetary policy tightening, a "sufficient amount" of data is needed on core inflation, wages, and business and consumer expectations for price increases. He further noted the ECB should consider the possibility that weak demand and slowing economic growth will ease inflationary pressures.
ECB Vice President Luis de Guindos bluntly stated that upcoming economic activity data "will not look good." He pointed out that the energy shock is reflected in inflation indicators much faster than in growth indicators, and its drag on growth will become more apparent in the coming weeks. Guindos therefore urged "prudence" regarding rate decisions. He emphasized that even if a ceasefire is reached soon, the conflict will leave "scars"—some infrastructure has been destroyed, and consumer confidence has already declined. Guindos warned, "Key indicators are already falling. Whatever the specific factors pushing up energy prices, their impact on confidence is sometimes underestimated by us."
Overall, the ECB currently faces a complex policy environment. On one hand, the Middle East situation is pushing up international oil prices and increasing inflationary pressures in Europe. On the other hand, slowing European growth and persistently weakening market confidence limit the space for further rate hikes.
As the Middle East situation continues to escalate and international energy prices remain high, market discussions about the ECB's future monetary policy path are clearly intensifying. However, TD Securities' latest view indicates the institution is notably cautious in its judgment of the ECB's June policy outlook. Contrary to some current market expectations, TD Securities believes the ECB is more likely to choose to keep rates steady at its June meeting rather than hike further.
TD Securities points out that the European economy still faces growth slowdown pressures, and market concerns about the "second-round effects" of inflation have not fully materialized. The so-called "second-round effects" mainly refer to energy price increases further pushing up wages, services, and core consumer prices, forming long-term inflationary pressure. TD Securities believes that Europe has not yet shown sufficiently clear signs of runaway wage and core inflation, so the ECB lacks the immediate necessity to hike in the short term.
TD Securities stated that in the weeks leading up to the ECB's June policy meeting, three different scenarios could emerge. The first scenario is a gradual de-escalation in the Middle East, with energy prices falling, potentially leading to a temporary easing of inflationary pressures in Europe. The second scenario is the current stalemate persists, with oil prices remaining high, but internal demand in Europe remains weak. The third scenario is a renewed escalation in the Middle East, coupled with clear second-round inflation effects in Europe, with wages and service prices continuing to rise rapidly.
TD Securities notes that only the third scenario could truly prompt the ECB to reconsider a rate hike. Currently, the combined probability of the first two scenarios is still above 50%. Therefore, TD Securities believes the ECB is more likely to keep rates unchanged in June, continue observing subsequent data changes, and allow the currently tight financial conditions to continue exerting their inflation-dampening effect.
In fact, European financial conditions have already tightened significantly. Eurozone financing costs remain high, corporate loan demand continues to decline, and the real estate market is also suppressed by high interest rates. Meanwhile, fiscal pressures in some European countries remain substantial, and the high-interest-rate environment is gradually affecting government debt financing costs.
Comments