Wars in the Middle East and Ukraine have determined a “further increase in the profile of the energy prices” which in August accelerated further to 14,3% from 10,3% in July and a “significant contribution from refining margins”. “This is likely to maintain inflation overall well above the target until the first half of 2027". The European Central Bank writes this in Economic bulletin, adding that “thereafter, the energy component should decline and remain negative until mid-2028, inducing a decline in overall inflation”.
It is also expected that "energy price increases will gradually be passed on to the energy component food and basic goods”According to the Eurotower, "the improved economic outlook should also contribute to a slight increase in core inflation, which would continue to rise until early 2027 and remain elevated for the rest of the year, then declining in 2028." In general, "headline inflation is expected to return around the target by the end of 2027, favored by the effects of higher interest rates".
ECB: "The economy is holding up despite the energy shock."
Despite the surge in energy prices the economy “has shown holding capacity in the second trimester 2026,” the ECB says, emphasizing that “growth was broad-based across countries and sectors. This trend is expected to continue in the third quarter.”
In the Economic Bulletin, the Eurotower notes that “the strength of the investments related to artificial intelligence has compensated for the difficulties caused by the conflict in the Middle East”. Not only that, “the manufacturing sector continues to deliver solid results in the context of increased public spending on defense and infrastructure” and “the consumer confidence marked a recovery from the low levels reached, contributing to the recovery of services from the initial energy shock". digital services, moreover, "business investments and exports show an increase in activities related to artificial intelligence".
The ECB notes that "over a short-term horizon, the growth prospects have improved compared to the June 2026 projections, reflecting, in particular, the resilience of private consumption and public spending,” while “in the medium term, consumption should be supported by the gradual decline in energy prices and the strength of the labor market.” Growth “will be increasingly fueled by business and residential construction investments” and “the expansion of exports should benefit from increased external demand, but is held back by difficulties related to competitiveness and uncertainty about global trade policies.”
ECB: Wages slow, profits accelerate
“At this stage, wages are not showing a significant reaction to the energy shock,” the European Central Bank notes, specifying that “in the second quarter of 2026, labor costs per employee increased at a year-on-year rate of 3,3%, slowing from the 3,5% recorded in the first quarter.”
Rising labor productivity also “helped contain growth in unit labor costs, which slowed to 2,6% from 3,5% in the first quarter,” while “at the same time, growth in unit profits rose from 0,3% to 2,2%.”
Deficit and interest expenditure forecasts
“The euro area general government budget balance is expected to deteriorate, with a deficit which in 2027 will reach a peak well above above the 3% threshold”, we read in the Bulletin, in which the ECB underlines that the deficit “should register a sharp increase in 3,6% of GDP in 2026"from 3% in 2025" and reach a peak of 3,7% in 2027, before decreasing marginally to 3,6% in 2028."
Furthermore, “it is expected that the interest expense increases of 0,2 percentage points of GDP in 2026 and of a further 0,3 percentage points in cumulative terms in the two-year period 2027-2028”. Consequently, “over the projection horizon, the euro area debt-to-GDP ratio is expected to follow an increasing path, leading it to reach a level just below 90% of GDP in 2028”.
The outlook for inflation and growth
"The outlook remains highly uncertain, with upside risks to inflation and downside risks to economic growth," the ECB forecasts, emphasizing that "regarding the energy shock, the new scenarios developed by experts illustrate the wide variety of developments that growth and inflation would experience given varying assumptions about the shock's intensity and duration, as well as its indirect and second-round effects."
The conflict in the Middle East, the Eurotower notes, "continues to put pressure on inflation, which is expected to remain at levels significantly above target for a prolonged period of time."
In this context, the decision to raise interest rates on September 10 “reflects the Governing Council’s commitment to designing monetary policy in such a way as to ensure that inflation stabilizes around its medium-term aim of 2%.”
