Under Internal and External Pressure: The European Economy Faces Slowing Growth and Rebounding Inflation

Against the backdrop of easing geopolitical conflicts in the Middle East and weak domestic growth, the European economy is in a complex situation of intensifying stagflation risks, weakening recovery momentum and mounting policy pressure. Several key data releases and market performance on the day further confirmed that the euro zone economy is facing a severe test from both internal and external headwinds, casting a lasting shadow over its growth outlook.

The final euro zone services PMI for March, released at 16:00 on April 8th, stood at 50.1, unchanged from the flash and previous readings, barely above the boom-bust threshold but at its lowest level in ten months. The figure revealed near-stagnant expansion in the euro zone services sector, while the composite PMI final reading came in at 50.7, also a nine-month low. Chris Williamson, Chief Economist at S&P Global, stated bluntly that the conflict in the Middle East had dealt a “heavy blow” to the euro zone economy, erasing the growth signs seen earlier this year. Deterioration on the demand side was particularly notable: new business in the private sector fell for the first time in eight months, export orders contracted continuously, and international services demand posted the steepest drop in six months. The simultaneous weakening of domestic and external demand has become the main driver of the economic slowdown.

Growing divergence among core economies highlighted internal imbalances in Europe. As Europe’s economic engine, Germany recorded a final services PMI of just 50.9 in March, down sharply from 53.5 in February and hitting its lowest level since September last year. Elevated energy costs and business uncertainty suppressed services activity, with new business shrinking for the first time since September and business confidence falling to a three-month low. The situation in France was more severe, with the services PMI final reading at 48.8, remaining in contraction territory for two consecutive months, and the composite PMI also falling to 48.8, significantly raising stagflation risks. French consumption and investment remained weak, and coupled with the impact of rising energy prices, the economy was mired in a “low growth, high inflation” predicament. In contrast, Spain emerged as the euro zone’s “growth champion” thanks to a tourism recovery and resilient exports, leading the core economies in growth, yet it could not reverse the overall downward trend of the region.

Price and consumption data further exposed stagflation pressures. Although the specific figures for the euro zone’s monthly PPI and retail sales in February, released at 17:00, were not available, market expectations were far from optimistic. Driven by the Middle East conflict pushing up energy and raw material prices, the euro zone’s annual HICP inflation rate rebounded to 2.5% in March, ending a consecutive decline. Input cost inflation surged to a more than three-year high, with manufacturing costs posting a record monthly increase, forcing enterprises to pass on costs and exacerbating inflationary pressures. Meanwhile, real household incomes were eroded by inflation, consumer sentiment remained subdued, and February retail sales were likely to stay weak, further weakening domestic demand as a pillar of the economy.

Financial markets and institutions sent synchronized pessimistic signals. Major European stock indexes closed sharply lower on April 7th: Germany’s DAX fell 1.03%, France’s CAC 40 dropped 0.67%, the UK’s FTSE 100 lost 0.83%, and the Euro Stoxx 600 slid 1.01%. Heightened investor risk aversion, combined with weak economic data, weighed heavily on equity markets. On the currency front, the pound fell to an eight-month low against the euro, dragged down by U.S. tariff policies and a weak UK economy. Institutions have been cutting growth forecasts: UBS lowered its 2026 euro zone GDP growth forecast from 1.3% to 0.8%, with Germany and Italy revised down to 0.6% and 0.5% respectively, warning that a prolonged conflict could trigger a deeper recession.

The European Central Bank’s monetary policy is caught in a dilemma. Governing Council member Robert Holzmann previously stated that if the Middle East crisis drags on, the ECB would need “a series of rate hikes” to counter inflationary rebounds; if the conflict eases, rate hikes could be taken off the table. With inflation rising and growth stalling, the ECB is torn between fighting inflation and stabilizing growth. The temporary ceasefire agreement between the U.S. and Iran and the resumption of shipping through the Strait of Hormuz on April 8th sent international oil prices plunging by more than 10%, temporarily easing Europe’s energy inflation pressures, but medium- and long-term uncertainties remain. Market expectations for ECB rate cuts have been delayed again, and the prolonged high-interest-rate environment will continue to suppress corporate investment and household credit demand, dragging on the economic recovery.

In addition, deep-seated structural contradictions within Europe have continued to stand out. German Chancellor Friedrich Merz criticized the EU on the day for excessive regulation and inefficient approval processes, noting that “large-scale photovoltaic power plants are built in months in China, while EU projects take years to get approved.” He called for a “silent approval” rule to streamline administrative procedures and unlock economic vitality. His remarks reflected divisions and urgent demands within the EU over reform and competitiveness enhancement. Long-standing rigid institutions, along with high welfare and tax burdens, have continued to erode Europe’s growth potential.

Overall, the European economy is characterized by “slowing growth, rebounding inflation, weak confidence and constrained policies”. The easing of the Middle East conflict has provided short-term relief, yet the euro zone’s insufficient endogenous momentum, prominent structural problems and complex external environment have not been fundamentally resolved. The economy may maintain weak expansion in the short term, but the risk of a contraction in the second quarter rises significantly if energy prices fluctuate again and external demand remains weak. Europe’s economy stands at a critical juncture: whether it can break free from stagflation depends on the evolution of the geopolitical situation, the ECB’s policy balancing act, and the progress of internal reforms.