The EU’s Spring Economic Forecast is downgrading growth as inflation gathers pace. The likelihood of interest rate rises, and exchange rate volatility, has risen as a result.
The European Commission’s annual Spring Economic Forecast made sobering reading for policymakers and businesses last week. The document predicts slowing growth and rising inflation in the bloc, reflecting the impact of the conflict in the Middle East on the eurozone economy. GDP growth in the EU is now projected to slow to 1.1% in 2026 from 1.5% in 2025, while inflation leaps from 2.5% to 3.1%. The inflationary environment may convince EU policymakers to raise interest rates soon, with many investors now predicting a 25 basis-point increase in June.
The immediate impact on the euro was muted. The currency weakened by around 0.8% against the dollar over the month of May, though hopes for a peace deal in the Gulf helped steady markets last week. The pound also fell by around 1% against the dollar over the month, caused by a combination of war in the Middle East and political turmoil in the UK.
What’s the Fed thinking?
New Federal Reserve (Fed) Chairman Kevin Warsh was President Trump’s pick for the role because he is considered more dovish on interest rates than previous incumbent Jerome Powell. Nevertheless, there is significant doubt about the Fed’s ability to lower rates under current conditions.
In fact, markets are now beginning to consider the possibility of rate hikes in the US this year. That would have been almost unthinkable in February, but the sentiment reflects inflationary pressures caused by President Trump’s Middle East war and the closure of the Strait of Hormuz. Rate rises would bring US monetary policy more in line with thinking in the UK and EU, where interest rate hikes are expected sooner rather than later. Will the Fed risk Trump’s wrath? It’s one to watch.
The week ahead
The potential for a peace deal in the Middle East will again be front and centre this week, as reports of progress in negotiations continue to filter through. Elsewhere, inflation rate flash figures (Tuesday) and retail sales (Thursday) will be the focus in the eurozone. In the US, labour market data (Thursday and Friday) will be closely watched, while house prices (Monday) and mortgages (Tuesday) are centre stage in the UK.
