Middle East conflict sparks a surge in Eurozone March inflation expectations, consumer confidence drops to a two-and-a-half-year low

The European Union’s business and consumer survey released on Monday showed that as fighting in the Middle East has continued for an entire month, business confidence in the euro area is accelerating its slide, while rising inflation expectations have also sent a fresh warning to the European Central Bank.

Specifically, an indicator measuring consumers’ price expectations for the next 12 months** surged from 26.2 in February to 43.4**, and business managers’ expectations for selling prices also rose significantly.

（Source: EU Business and Consumer Survey）

The report said that sales price expectations among managers across all industries rose significantly across all business areas, with the increase especially pronounced in the industrial sector. Sales price expectations across industries also rose further above their long-term averages. Consumers’ perceptions of price trends over the past twelve months rose moderately, but their expectations for price trends over the next twelve months jumped sharply.

Amid sudden turbulence in the economic outlook, the economic sentiment indicator (ESI) measuring business and consumer attitudes in the euro area also fell to 96.6, from 98.2 in February; this drop was also larger than that of the pre-consensus expected by Wall Street analysts (96.8).

（Source: EU Business and Consumer Survey）

Among them, consumer confidence in the euro area fell sharply to a two-and-a-half-year low. The report said the main reason was that residents’ expectations for their country’s overall economic outlook deteriorated significantly; at the same time, residents became more pessimistic about their household finances going forward, and their willingness to make large purchases over the next 12 months fell markedly.

Since the survey was conducted between March 1 and 24, if the fighting in the Middle East continues, there is reason to believe that conditions in the next survey could be even worse.

For capital markets, this report also makes the European Central Bank’s outlook for monetary policy even more opaque: on the one hand, inflation expectations for both businesses and consumers surging together could trigger an inflation “spiral upward”; meanwhile, the drop in consumer confidence would also dampen economic growth, forcing firms to cut back investment and households to save more.

Money markets currently expect the ECB to raise rates three times this year, which contrasts sharply with the market view from weeks ago, when there was still a 35% probability of a rate cut.

Regarding the fastest outlook for an “April rate hike,” ECB President Lagarde said in a speech last week that while the current situation is different from 2022, when inflation was pushed into double digits, “there is reason to remain vigilant.”

In her remarks, Lagarde also outlined three possible ways the ECB could respond to the current situation. She said:

For energy shocks that are limited in scale and short in duration, the classic approach would be to temporarily ignore their impact. Because there is a lag in policy transmission, monetary policy responses are often too late—possibly even counterproductive.

For inflation overshoots that are larger in scale but not lasting long, policymakers may need to make a certain degree of cautious adjustment to policy. If the reason for deviating from the inflation target comes from an exogenous supply shock rather than overly strong demand, then the optimal policy action should be more moderate, but that does not mean there can be no response at all.

For inflation deviations from the target that are significantly sized and last a long time, the policy response must be strong enough or persistent enough; otherwise, self-reinforcing mechanisms will start to take effect, and the risk of inflation expectations becoming unanchored will rise significantly.

In the economic outlook released in March, the ECB has already raised its baseline inflation expectation for 2026 substantially to 2.6%, and warned that in extreme cases involving disruptions to energy supply, the region’s inflation rate could reach 6.3% at the beginning of next year.

（Source: Caixin/ Financial Link News）