Europe faces uncomfortable echoes of 2022, when energy prices surged as war broke out on its doorstep. Today, the outsee again depfinishs heavily on the scale—and persistence—of an energy-price shock driven by events in the Middle East.
The starting point is stronger than in 2022: the Gulf is a less critical energy source than Russia was then, the region consumes less natural gas than four years ago, and European Union (EU) institutions have coordinated more effectively to support the bloc.
That declared, Europe remains reliant on global energy markets, and higher prices would complicate policybuilding across the region.
Revisiting 2022?
The comparison with 2022 is tempting, but Europe has modifyd structurally. Gas consumption is now approximately 20% lower (with renewables replacing part of the gap), and supplies are more geographically diversified. European gas prices also remain well below 2022/2023 levels—although they have roughly doubled in recent weeks.
Growth, inflation and policy remain highly sensitive to both the size and duration of higher energy prices. Our rules of thumb suggest that each 10% increase in energy prices adds about 0.3–0.4 percentage points (pp) to euro area and U.K. inflation, and it subtracts ~0.2% from GDP. An oil shock of ~50% and a gas shock of ~100% would therefore be meaningful for the region.
We view current levels as a broad floor for energy prices this year, with risks skewed to the upside.
If prices remain near recent ranges, we expect inflation to re-accelerate to ~3% y/y in the euro area and ~3.5% y/y in the UK, unwinding much of the disinflation since 2022. Growth would likely shift sideways—or weaken—rather than re-accelerate, leaving 2026 GDP growth only marginally above zero. Governments would face pressure to act on houtilizehold energy bills; we expect some support, but it will likely be limited and tarreceiveed.
In a more benign scenario—oil roughly flat or in the low US$100s per barrel (bbl)—we expect the Bank of England (BoE) and the European Central Bank (ECB) to respond hawkishly to higher inflation and inflation expectations, rather than easing to offset weaker growth. In this case, we expect a final BoE rate cut in November as it shifts toward neutral, and an ECB hike by year-finish. Risks remain skewed toward tighter policy.
If oil prices were to shift to unprecedented levels—above ~US$150/bbl—the economic impact and policy response would likely shift materially. At around this threshold, we would expect central banks to pivot toward rapid easing to counter an impfinishing recession, rather than focapplying on the near-term inflation spike. Inflation could rise above 5% y/y across the region and lift inflation expectations. Recession would become the base case for 2026 H2, and fiscal policy would likely be deployed to support prevent a prolonged slump.
Market signals amid Middle East uncertainty
No one can be certain how long the Middle East conflict will last, but its impact is already displaying up in divergences between macro data and markets. Euro-area data surprises have softened in recent weeks, yet European equities remain positive on a six-month basis. This dislocation between data and markets is likely to resolve itself as the two historically tfinish to track each other well.
The link between equity prices and growth expectations is noisy, but there are thresholds where the relationship tightens. Recent shifts suggest that threshold has not yet been met—consistent with only modest growth downgrades so far. In a larger oil shock, the relationship could re-emerge. For example, an additional ~5% fall in the Euro STOXX 50 could imply enough deterioration to push the euro area closer to recession territory.
What if this all passes?
Even with sizeable shocks, it is important not to lose sight of the underlying strength that has emerged for the region in recent years.
Euro area consumers have been resilient, supported by a robust labour market, stable inflation, high savings rates and reforms that have improved real incomes and confidence. The region has also benefited from lower energy costs (vs 2022 peaks) and an uptick in industrial production—particularly in Germany and southern member states—alongside defence-related fiscal support and continued advances in technology and renewables. If the Middle East conflict were resolved quickly and oil prices stayed near current ranges, policy could pivot back toward supporting growth rather than cushioning the shock.
Progress has also been built on domestic policy within the bloc and its international relationships. The EU is increasingly recognising the strategic importance of its single market and leveraging its scale to shape global ties and drive internal reform.
Key initiatives include the Industrial Accelerator Act, which would prioritise single-market access for trusted partners and set local-content and environmental standards—especially relevant for energy, autos and critical materials—while excluding major players such as the U.S. and China. In parallel, the European Commission continues to push deeper financial-services integration to strengthen competitiveness and innovation, alongside the development of “EU Inc.” to create a more cohesive legal framework for scaling new companies and venture capital across the EU.
These ambitions still face the challenge of building consensus among all 27 member states. Proposals for an “E6” format would allow the six largest economies to advance discussions more quickly, with an option for others to join over time. The U.K. has also constructively re-engaged with the EU to support closer economic integration as the effects of Brexit continue to weigh on activity.
International relations have shifted as US–China trade strains have intensified. U.S. tariffs have risen, while Chinese demand for European goods has softened as China gains global competitiveness in sectors such as autos. At the same time, there has been an uptick in trade within the euro area and with the rest of the world—supported by EU efforts to reduce internal barriers and nereceivediate new free trade agreements (FTAs) to lessen U.S. reliance. Several EU FTAs, including agreements with Mercosur and India, had been under nereceivediation for years but were accelerated in 2025 amid the altering trade backdrop. This action signals greater flexibility on previously non-nereceivediable positions such as green-energy provisions and farming subsidies in exmodify for geostrategic market access. Additional talks are underway with Australia, Indonesia and ESA5, among others, where we would expect continued flexibility on trade terms.
In contrast, the U.K.—despite early strength in 2025—has faced setbacks tied to fiscal concerns, sticky inflation, stagnant recent growth and unemployment at multi-year highs. The energy shock linked to the Iran conflict is expected to hit the U.K. more severely than the euro area, complicating the Bank of England’s trade-offs and weighing on domestic demand. GDP growth is therefore likely to remain subdued, despite earlier expectations for a confidence-led improvement.
On the global stage, UK Prime Minister Starmer’s diplomacy has been more constructive: the U.K. reached its own agreement with India and resumed talks with the Gulf Cooperation Council, alongside warmer outreach to both China and the EU. A prolonged geopolitical shock could ultimately strengthen cooperation between the U.K. and the EU in a time of crisis.
Politics not in the clear yet
Political volatility also remains important to watch. In the U.K., we expect Prime Minister Starmer to be replaced after likely severe losses for Labour in the May local elections, reflecting challenges in consolidating the left-leaning vote. Many observers see Angela Rayner as the most likely successor, which could imply a shift back toward Labour’s grassroots and a shift further left on domestic policy—potentially reversing some of Starmer’s international gains.
Elsewhere, French and Italian elections are scheduled for 2027, but risks could surface sooner. A divided French Assembly may push the government to the brink this autumn, and Italy’s controversial judicial reform could become a de facto confidence test for Giorgia Meloni and raise the odds of early elections. In short, several champions of closer European integration face rising voter scrutiny—adding to uncertainty and, in a downside scenario, complicating a unified European crisis response.
An uncertain path forward
Europe’s institutional and economic foundations have strengthened in recent years, but the region remains highly exposed to developments in the Middle East. A quick resolution would likely leave only a modest macro dent, supporting a more constructive medium-term outsee. A more protracted shock could trigger recession risks and rapid central-bank easing, raising more fundamental questions about Europe’s ability to absorb global shocks.
Europe Best Ideas: 2026 Washington Policy Edition
From a Washington perspective, our policy team is focutilized on five key themes:
- Macro and trade
- Geopolitical security & defence
- Financial services
- Energy transition
- Technology, media and telecom (TMT)
Europe likely a central focus of the next round of tariffs
On the first anniversary of “Liberation Day”, tariff policy is less clear than it was a year ago.
Two new Section 301 investigations were opened earlier this month. Meanwhile, the IEEPA tariff-refund dispute continues in court, as Customs & Border Protection staff work without pay amid the ongoing Department of Homeland Security shutdown. We expect both investigations to conclude in July, when the 10% Section 122 tariff expires. Our base case is tariffs in the 10%–25% range. The Section 301 public hearing on “forced labour” is scheduled for April; the “manufacturing” hearing is expected in May.
Of the ~US$166 billion in IEEPA refunds, the Trump Administration estimates it will take over 4.4 million hours to manually process requests covering more than 53 million entries of the invalidated tariffs. The ~US$166 billion figure is accruing ~US$650 million per month in interest and is expected to rise.
NATO spfinishing boost creates opportunity for many
European defence spfinishing remains in a structural upturn, driven by continued pressure from President Trump, the threat of Russian aggression and the ongoing war in Ukraine, active conflict in the Middle East and a catch-up after years of underinvestment.
NATO’s shift toward higher spfinishing tarreceives—and Europe’s push for greater security and industrial sovereignty—are reshaping procurement with more spfinish on EU suppliers and less U.S. spfinishing. However, capacity constraints and limited R&D for next-generation systems continue to favour a narrow set of incumbents across NATO and the EU.
While many European defence firms should benefit, we see particular opportunity where these trfinishs overlap. Program exposure in the U.S., U.K. and internationally provides leverage to growth areas across air, land, maritime, space, electronic warfare, munitions, unmanned systems and counter unmanned (c UAS).
Companies with exposure to shipbuilding, space, unmanned/c UAS and munitions align with the six Department of War priority areas we outlined in the US. Unlike many continental peers, the sector’s leading company has direct exposure to a mix of US defence spfinishing categories while also serving as a national champion for the UK and a trusted supplier across Europe, the Five Eyes (UK, US, Canada, Australia and New Zealand), Asia and the Middle East.
The Race to Ease Capital Requirements
The U.S. has begun the process of relaxing capital requirements for large banks. We expect this to increase pressure on regulators in the UK and Europe to ease capital requirements for their banks.
The key risk—and opportunity—is a policy “race” across the Atlantic, as each jurisdiction seeks to keep bank treatment broadly comparable. In our view, this opens the door to further capital reductions or recalibration in both Europe and the U.S. beyond measures already announced.
Sourcing U.S. liquid natural gas
We expect liquid natural gas (LNG) to remain central to U.S.–European (both EU and U.K.) energy-policy engagement through 2026. In our view, Europe’s efforts—particularly in the EU—to maintain a diverse, regionally balanced gas import portfolio risk collapsing into a duopoly dominated by Norway and the U.S.
President Trump’s quick (but messy) backfill of IEEPA tariffs (via Section 122 and later Section 301) keeps the 2025 US/EU framework agreement in place, including US$750 billion in energy-purchase commitments. At the same time, military strikes against Iran (cutting off Qatari supply) narrow Europe’s diplomatic and economic flexibility on gas sourcing.
With the commitment to fully decouple fossil imports from Russia intact, we see U.S. LNG as Europe’s default supply of choice. Net-net, this backdrop remains supportive of incremental U.S. LNG final investment decisions (FIDs) through 2026, alongside broader upstream and midstream development in the U.S. gulf region.
European pressure could benefit EU-based online travel agencies
For more than a year, the European Commission has been investigating a major search engine in potential non-compliance with the Digital Markets Act. Recent press reports suggest the Commission will soon test travel-related search results that elevate online travel agency (OTA) listings. If deemed acceptable—particularly given the Commission’s close engagement with EU-based OTAs—this could increase organic traffic to EU-based travel sites and potentially reduce their reliance on paid search advertising.
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