Economic activity across the euro area is losing momentum at a pace that is beginning to alarm policymakers, as the fallout from the U.S.-Israeli war with Iran feeds through energy markets into prices, supply chains, and household demand.
Fresh survey data from S&P Global, published by Reuters, show the bloc’s private sector barely expanded in March, with the flash composite Purchasing Managers’ Index slipping to 50.5 from 51.9 in February, its lowest level in ten months and only marginally above the threshold that separates growth from contraction.
Beneath that headline figure, the deterioration is more pronounced. Input costs are accelerating sharply, delivery times are lengthening at the fastest pace since mid-2022, and business expectations are weakening, all pointing to an economy under strain from an external shock it is poorly positioned to absorb.
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The trigger is energy. Oil prices have surged since the escalation in the Middle East, driven in part by disruptions to key shipping routes, pushing up transport and production costs across Europe. The impact is already visible: petrol prices across the European Union have risen more than 10%, diesel by over 20%, compressing household spending power and eroding corporate margins.
“The flash euro zone PMI is ringing stagflation alarm bells as the war in the Middle East drives prices sharply higher while stifling growth,” said Chris Williamson, chief business economist at S&P Global Market Intelligence.
The data point to a classic stagflationary setup—weak growth combined with rising inflation. The manufacturing input price index jumped to 68.6 from 58.0, while the supplier delivery times index dropped to 40.9 from 47.3, signaling mounting supply bottlenecks and expectations of further price increases.
Economists say the euro zone entered this shock with limited buffers. Growth was already running at around 1%, leaving little room to absorb higher energy costs without a meaningful slowdown. Several member states, including Austria, Finland, and Portugal, have already revised down their growth outlooks, citing the drag from expensive fuel.
Germany, the bloc’s largest economy, has so far shown relative resilience in the latest data, but weakness is more evident elsewhere. France, in particular, has seen a sharp drop in business confidence, underlining the uneven nature of the slowdown.
Consumer sentiment is deteriorating even faster. Recent data showed euro area confidence falling to its lowest level since late 2023, in one of the steepest declines on record, as households adjust to higher living costs and growing economic uncertainty.
The external environment is compounding the problem. Trade data released earlier this month showed European exports already weakening before the conflict intensified, with shipments to the United States down nearly 28% year-on-year in January, alongside declines to China, the United Kingdom, and Japan. Analysts attribute part of that drop to shifting U.S. trade policy under President Donald Trump, which has added another layer of uncertainty for European exporters.
For the European Central Bank, the situation presents a familiar dilemma. Inflation had stabilized around its 2% target over the past year, but the latest energy shock is expected to push it higher. The ECB has already indicated that inflation could rise to at least 2.6% even under a relatively benign scenario, with risks tilted to the upside.
“The survey points to a large near-term inflation impact from higher energy that could feed into core prices,” said Raphael Brun-Aguerre of JPMorgan Chase. “The energy price shock could hit business profitability and has already damaged demand conditions and output more broadly in the region.”
Markets are responding by pricing in tighter monetary policy. Interest rates are moving higher as investors anticipate that the ECB may be forced to raise borrowing costs to contain inflation, even as growth slows. Mortgage rates have already begun to edge up, adding further pressure on household finances.
That policy response comes with risks. Central banks typically look through energy-driven inflation shocks, but the experience of 2021 and 2022, when similar pressures proved more persistent than expected, has made policymakers more cautious about waiting too long. The result is a tightening bias at a time when the economy is already weakening.
“The euro zone’s vulnerabilities are once again laid bare,” said Bert Colijn of ING Group. “For energy-intensive industry, this means that a recovery will be harder to achieve, which matters significantly for overall production.”
Financial markets are reflecting those concerns. Since the escalation of the conflict in late February, European equities have underperformed their global peers, with the STOXX 600 falling roughly 9%. That compares with a 4% decline in the U.S. S&P 500 and steeper losses in parts of Asia, highlighting how exposure to energy costs is shaping regional performance.
The divergence has led some investors to view the United States as relatively insulated.
“The U.S. can potentially absorb more economic impacts than other parts of the world can absorb. So I would expect it to outperform,” said Yung-Yu Ma of PNC Financial Services. He added, however, that “outperforming so far has meant being down… so it still can be painful.”
Markets briefly stabilized after Trump pointed to “productive” conversations with Iran, illustrating how sensitive sentiment has become to any sign of de-escalation. Oil prices eased from recent peaks, and equities staged a short-lived rebound.
But the underlying pressures remain unresolved. Energy infrastructure damage, supply bottlenecks, and geopolitical uncertainty mean that even a swift end to hostilities would not immediately reverse the economic impact. Fuel prices are unlikely to fall quickly, and supply chains could take months to normalize.
If diplomatic efforts fail and the conflict deepens, the consequences for Europe would be severe: higher energy prices, tighter financial conditions, weaker demand, and a greater risk that the current slowdown tips closer to stagnation.