The International Monetary Fund (IMF) has warned the war in the Middle East has significantly weakened the euro area’s economic outlook, lowering growth forecasts while pushing up inflation because of energy supply disruptions and tighter financial conditions.
In a report issued after the completion of its 2026 consultation on common euro area policies, the IMF projected euro area economic growth to slow from 1.4% in 2025 to 0.9% in 2026 before recovering modestly to 1.2% in 2027. At the same time, headline inflation is expected to rise from 2.1% in 2025 to 2.9% in 2026 before easing to 2.3% in 2027.
The IMF said the latest projections are 0.5% lower for 2026 and 0.2% lower for 2027 than estimates made before the Middle East conflict escalated. “The effects of the war in the Middle East include weaker confidence, tighter financial conditions and inflationary pressures,” it said in the staff report released after the IMF Executive Board concluded its annual discussions on common euro area policies.
The IMF warned that risks remain tilted toward weaker growth and higher inflation, with disruption to global energy supplies representing the biggest source of uncertainty.
A slower restoration of energy supply could further weaken economic activity while driving inflation higher, the Fund said. It also warned that renewed financial market stress, escalating geopolitical tensions, including Russia’s war in Ukraine, and uncertainty surrounding tariffs and trade policies could further weigh on the region’s economy.
The lender said financial stability risks have increased alongside the weaker economic outlook, warning that a sharp global risk-off episode or stress among leveraged non-bank financial institutions could spill over into banks and core funding markets. The Executive Board called for a carefully calibrated policy response, recommending that monetary policy remain data-dependent and focused on keeping inflation expectations firmly anchored.
Directors said fiscal policy should primarily rely on automatic stabilizers, with any discretionary support remaining temporary, targeted and designed to preserve market price signals. They also stressed the importance of credible medium-term fiscal consolidation plans, particularly for highly indebted member states, supported by spending reforms and effective implementation of the European Union’s fiscal framework.
The IMF reiterated that structural reforms remain essential to strengthen the euro area’s resilience and long-term growth prospects. Directors said deepening the E.U. single market, reducing cross-border barriers, improving labor mobility, strengthening artificial intelligence readiness and enhancing energy security through greater market integration should remain policy priorities. They also supported advancing the Savings and Investments Union, developing the digital euro and strengthening the E.U. budget to finance common priorities.
The Executive Board also welcomed the European Union’s efforts to diversify trade while supporting an open, rules-based global trading system. It said measures to reduce supply chain vulnerabilities should remain targeted to avoid unnecessary economic distortions and fiscal costs.
On financial stability, the IMF said the euro area’s banking system remains resilient but urged authorities to closely monitor risks from elevated asset valuations and the expanding role of non-bank financial institutions. Directors also called for stronger stress testing, enhanced supervisory capacity, completion of the Banking Union and full implementation of Basel III banking standards, while noting that stablecoins require continued regulatory oversight and international supervisory cooperation.