Eurozone

Iran War Impacts Energy Prices and Consumer Confidence

2026 was poised to be the year when the Eurozone would narrow the real GDP growth gap with the United States, thanks to rising real wages, normalized energy markets, and fiscal stimulus. Then the United States and Israel attacked Iran, unleashing a global surge in energy prices that is likely to hit Europe harder than any other major developed economy.

Entering 2026, benchmark natural gas prices had declined from a peak of over €300/MWh after Russia invaded Ukraine to under €30/MWh. While a majority of Eurozone economic activity is in the service sector, the decline in energy prices would have boosted industrial activity and helped ease the cost of living for households. After the attack on Iran, however, prices more than doubled before returning to ~€42/MWh by late June (Exhibit 10). The energy price surge had global implications—but Europe is feeling these challenges more acutely due to its dependence on imported energy.

Consumer confidence had also been recovering slowly before the Iran War, as unemployment fell to the lowest level since the creation of the euro in 1999, inflation returned to the ECB’s 2% target, and real wages grew moderately. But in the two months after the initiation of the Iran War, consumer confidence fell by the fourth-largest amount since the inception of the survey (Exhibit 11). Until the Iran War ends, I expect Eurozone consumer confidence to remain weak given energy supply vulnerabilities and the price shock being felt by European households.

ECB Expectations

Adding insult to injury, the ECB hiked rates by 25 bps on 11 June, and markets suggest at least one additional 25-bps hike by year end (Exhibit 12). Hiking interest rates will not increase the flow of crude oil or liquified natural gas through the Strait of Hormuz, but it will depress economic activity in a region that has seen lethargic activity levels for years.

Trade Tensions

The July 2025 Turnberry agreement capped US tariffs on European goods at 15%, though steel and aluminum remained subject to a 50% tariff. The European Union subsequently ratified the deal with conditions, but both sides were critical of the other’s compliance with the letter and spirit of the agreement. In early May, President Trump threatened to raise tariffs on European autos to 25%; if imposed, the agreement could unravel—reigniting a trade conflict between two blocs that exchange over $1 trillion in goods annually. I expect trade tensions between the United States and European Union to persist.

Defense Ramp

A bright spot for Eurozone growth is the increase in defense spending (Exhibit 13). While the ramp in German defense spending is most notable, the increase in non-US NATO defense spending has already been impressive with a 37% real increase from 2023 to 2025. Going forward, spending on the military will more than double to over $1 trillion over time if non-US NATO members comply with the commitments they made in 2025 to spend 5% of GDP on defense and related infrastructure. This could lead to significant increases in industrial activity and technology investment, but also larger fiscal deficits.

Initially, I expect the traditional industrial sector to benefit from the military spending boost. Excess capacity in the auto industry can be repurposed in a matter of months to produce military equipment, such as armored personnel carriers and tanks, while retaining many of the original workers. Longer term, I expect higher military and related infrastructure investment to improve Europe’s competitive position in technology, with defense-tech innovation helping to raise the region’s productivity growth rate. Some benefits of this spending will only be evident years from now, but I expect the payoff will be material.