Data released on Thursday show consumer sentiment in the euro zone’s three largest economies slipping as the conflict in the Middle East feeds through to energy prices and heightens worries about broader cost-of-living pressures.
In Germany, an index tracking consumer sentiment dropped to its weakest reading in two years this month. Comparable surveys in France and Italy also point to increasing unease among households, reinforcing a pattern economists expect to persist over the coming months.
"It’s likely to get worse before it gets better," said Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management. Ducrozet noted that, so far, consumers have primarily experienced a jump in prices at the pump. He added that a further rise in food prices may still be coming as fertilizer shipments are disrupted by activity around the Strait of Hormuz.
Business sentiment shows strains as well. A separate survey found that French industrialists have grown more negative about the business climate. German business morale has also slipped, according to a different survey published earlier this week.
Economists across the euro zone and beyond, most recently at the OECD, have issued warnings that the combination of weaker sentiment and higher energy costs could slow growth or even tip some economies into recession.
ING senior economist Charlotte de Montpellier cautioned that recent developments are not fully captured in the March data because of the timing of survey collection. "If the conflict does not ease in the coming days, a much sharper deterioration in sentiment can be expected in April," she said.
Policy makers are watching closely. The European Central Bank has signalled it will act to prevent a fresh energy-led spike in inflation from becoming entrenched, strongly implying further interest-rate increases in the months ahead. Market pricing currently points to two or three rate hikes this year, and longer-dated bond yields - a market gauge of borrowing costs - have climbed.
Those higher financing costs are likely to compound the economic effects of the conflict, potentially adding pressure on households and firms already facing rising prices.
Ducrozet suggested the ECB could be forced to reverse course if the growth outlook worsens significantly, saying the central bank might find itself cutting rates next year should slowing activity pull inflation back down. "The question is how fast the evidence will come in if they are wrong and need to reverse the hikes," he said.
He also argued that fiscal support this time around is likely to be less generous than during the previous energy-driven inflation episode in 2022, and that economic expansion may already be weaker at the outset.
Despite tightening sentiment, some indicators remained steady before the latest spike in tensions. ECB data released on Thursday showed growth in bank lending was stable in February, suggesting economic activity across the bloc had been expanding at a moderate pace prior to the outbreak of the Iran war.
Finnish central bank governor Olli Rehn added a cautionary note, saying the ECB should assess the economy as a whole and not focus narrowly on oil prices when setting policy.
Key developments to watch in the near term include how quickly energy and food prices move higher, whether business and consumer sentiment deteriorates further in April, and how monetary and fiscal authorities respond if growth and inflation trends diverge.