On Thursday, European Central Bank President Christine Lagarde issued one of her most direct warnings to date regarding the potential inflationary consequences of the ongoing conflict involving Iran. She stated that the war "significantly increases uncertainty for the outlook" and will have a "substantial impact" on inflation in the near term. Energy shocks have become a core factor driving upward revisions to inflation. Lagarde emphasized that the conflict is creating "upside risks to inflation" through oil and gas markets, with a direct effect on consumer prices. The ECB's latest staff projections show inflation averaging 2.6% in 2026, before declining to 2.0% in 2027 and 2.1% in 2028. Compared to previous forecasts, the upward revision primarily stems from higher energy prices linked to the Middle East conflict. Core inflation, which excludes energy and food, is projected to remain slightly above target throughout the forecast period, reflecting the indirect pass-through effects of energy costs across the economy. However, Lagarde clarified that this baseline scenario assumes relatively limited disruptions to energy supply. Under a more adverse scenario—should oil and gas supplies through the Strait of Hormuz face a stronger and more prolonged shock—inflation could rise to 3.5% in 2026. In a severe scenario, where energy prices remain elevated for an extended period, overall inflation could even reach as high as 4.4% in 2026. The ECB is paying particular attention to so-called "second-round effects," where the initial energy shock spreads to wages, services, and core inflation. Lagarde stated, "If persistent, higher energy prices could trigger broader inflationary pressures through indirect and second-round effects—a situation that requires close monitoring." The inflationary pressures from energy markets coincide with a critical juncture for the Eurozone economy. GDP growth for 2026 has been revised down to just 0.9%, nearing stagnation, as the war weighs on real incomes, business confidence, and consumption. This complicates the policy environment: an oil price shock simultaneously pushes inflation higher while dampening growth by eroding real incomes and weakening confidence. Lagarde reiterated that a prolonged conflict would both elevate inflation and weaken economic activity, making the ECB's policy response more challenging. Lagarde indicated that policymakers are closely monitoring key indicators, including wage growth, inflation expectations, and developments in energy markets. She said, "We will not pre-commit to a particular interest rate path. If necessary, the ECB will adjust its policy tools to ensure inflation returns sustainably to target." With the situation around the Strait of Hormuz unresolved and the potential for escalation related to Iran capable of triggering sharp oil price volatility at any time, the ECB faces an unusually wide range of uncertainties ahead of its April 30 meeting. Analysis suggests Lagarde's message is essentially one of "prudent watchfulness": the ECB possesses policy tools, a data-dependent framework, and, for now at least, a sufficient time window to continue observing developments before taking action. Lagarde urged governments not to "overreact" when helping citizens cope with surging energy prices, emphasizing the need for fiscal restraint. Analysis indicates her remarks appear to be a warning against repeating the large-scale fiscal assistance seen following the outbreak of the Russia-Ukraine conflict in 2022. Lagarde stated: The Governing Council emphasizes the urgent need to strengthen the Eurozone economy while maintaining sound public finances. Any fiscal response to energy price shocks should be temporary, targeted, and tailored. Fiscal deterioration resulting from the COVID-19 pandemic and the energy crisis, along with the consequent rise in refinancing costs, has significantly constrained the policy space for many European countries. Should the conflict persist, any measures would need to be more precisely targeted towards vulnerable households and, where appropriate, energy-intensive industries. Due to the persistent energy shock stemming from the Iran conflict, European governments have begun implementing response measures. Brent crude prices remain above $100 per barrel, and European benchmark natural gas futures rose sharply on Thursday following damage to a major liquefied natural gas export facility in Qatar. Lagarde also acknowledged that the energy shock is already affecting consumers, stating it is "eroding real incomes and confidence," a impact that would intensify under the ECB's more extreme forecast scenarios. She used the occasion to reiterate the necessity of advancing energy decarbonization and economic reforms: "The current energy crisis underscores the urgency of further reducing dependence on fossil fuels. Completing the Capital Markets Union is essential for funding innovation and supporting the green and digital transitions." The Iran conflict was also a central topic at the EU leaders' summit in Brussels on Thursday. Lagarde cut her press conference short to attend the meeting.
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