Geopolitical Shocks and Inflation Rebound Put European Economy to Stagflation Test

The European economy is under multiple pressures including the escalation of geopolitical conflicts, unexpected rebound in inflation, significant fluctuations in the financial market, and the rising expectation of a policy shift in monetary policy. Iran announced complete control and blockade of the Strait of Hormuz, directly impacting Europe's energy supply and trade routes; the inflation data for the eurozone in February unexpectedly rose, breaking market expectations for a rapid easing by the European Central Bank; coupled with the spread of global risk aversion, European stocks, bonds, and currencies simultaneously weakened, significantly increasing the risk of "stagflation", becoming the core focus of global macro markets on that day.

On March 3rd local time, the European Union Statistics Office released the initial CPI data for the eurozone in February. The overall inflation rose by 1.9% year-on-year, higher than the previous value of 1.7% and market expectations of 1.7%; core CPI rose by 2.4%, also higher than the previous value and expectations of 2.2%; service inflation even rose to 3.4%, indicating strong price stickiness in the domestic demand sector. After the data was released, the market quickly revised its monetary policy expectations. Previously, the widely expected rate cut by the European Central Bank in June largely disappeared, and some trading desks began to price in a 25 basis point rate hike possibility this year, with the probability rising to 50%. The chief economist of the European Central Bank, Lane, stated that he would closely monitor the impact of the Middle East situation on energy and inflation. Energy supply disruptions may bring a new round of imported inflation pressure, prolonging the process of inflation returning to the 2% target.

The blockade of the Strait of Hormuz and the military conflict in the Middle East are the biggest external shocks to the European economy. Europe is highly dependent on Middle Eastern crude oil and liquefied natural gas. Approximately 20% of the LNG trade and 30% of the maritime oil trade are transported through this strait. Qatar, as an important LNG supplier to Europe, has seen significant impacts on its exports and production. From March 3rd to 4th, the TTF natural gas price in Europe soared by over 30% in a single day, Brent crude oil stabilized above $81 per barrel, with an intraday increase of nearly 5%. The rapid rise in energy prices will directly push up European industrial production, transportation, and consumer costs, further intensifying inflationary pressure. Although Europe's current storage levels and energy diversification are better than during the 2022 energy crisis, continuous supply disruptions will significantly raise the inflation base, suppressing industrial profits and the actual purchasing power of residents.

The shipping and trade chains are simultaneously under pressure. Key hubs such as Jebel Ali Port in the United Arab Emirates have suspended operations due to security risks, and routes from the Middle East to Europe and from the Middle East to Asia have been largely suspended or rerouted via the Cape of Good Hope. The voyage and transportation costs have significantly increased. The import and export of raw materials for industries such as automobiles, machinery, chemicals, and home appliances have all been disrupted, and problems such as cross-border logistics delays, skyrocketing freight, and difficulties in order fulfillment have emerged in a concentrated manner. For Europe, the Middle East is not only an energy source but also an important export market. The regional turmoil will directly drag down European external demand, exacerbating the already weak economic recovery.

The financial market presents a "stock-bond-currency triple blow" pattern. At the close on March 3rd, the main European stock indices suffered a significant decline. The German DAX index dropped by 3.44%, the French CAC40 index dropped by 3.46%, the British FTSE 100 index dropped by 2.75%, and the European STOXX 600 index dropped by 3.08%. The automotive, manufacturing, retail, and technology sectors led the decline, with only the energy sector relatively resistant. In the bond market, the yields of German, French, Italian, and British government bonds generally rose. The 10-year German government bond yield rose to 2.752%, and the spreads of marginal countries such as Italy and France widened, further suppressing investment willingness. In terms of exchange rates, the euro depreciated against the US dollar to 1.1589. The strengthening of the US dollar index attracted risk-averse funds to flow back, and euro assets are facing short-term pressure from capital outflows.

From an economic fundamentals perspective, although the PMI index for the European manufacturing sector rose above the critical level in February, indicating a marginal improvement in the production sector, the problems such as weak domestic demand, tightened credit, and intensified external shocks have not been resolved. The retail and consumption data in core economies like Germany and France are relatively weak, and the tight labor market has pushed up wages, creating a risk of a "wage-price" spiral increase. The European Central Bank is in a dilemma: premature easing might lead to repeated inflation, while maintaining high interest rates or even tightening policies would exacerbate economic downward pressure, and a stagflationary pattern is emerging.

Overall， on March 4th， the core logic of the European economy has shifted from "moderate recovery + gradual interest rate cuts" to "inflation rebound + geopolitical shock + policy tightening expectations". Short-term market fluctuations will continue to revolve around the evolution of the situation in the Middle East， the trend of energy prices， inflation data， and the statements of the European Central Bank. If the封锁of the Strait of Hormuz continues and the conflict in the Middle East further escalates， European inflation may once again exceed the 2% target， and economic growth may be forced to be lowered； if the situation eases and energy prices fall， the European Central Bank is still expected to launch easing measures in the second half of the year. For enterprises and investors， energy costs， supply chain stability， exchange rate fluctuations， and financing costs will become the key variables affecting the European economy and market in the future.