A sharp rise in energy prices, driven by the ongoing conflict in the Middle East and the Iran war, has significantly impacted economic sentiment and policy outlooks across Europe and Australia. In Germany, the Ifo index—a key leading indicator—fell to 86.4 in March from 88.4 in February, with expectations suffering their worst decline since the Russian invasion of Ukraine, dropping to 86.0 from 90.2. ING’s Carsten Brzeski attributes this slump to soaring energy prices, geopolitical tensions, and renewed uncertainty, warning that Germany’s anticipated cyclical rebound is now at risk, though he notes that over €200bn in fiscal stimulus for defence and infrastructure could still support recovery prospects [1].
The European Central Bank (ECB) is responding to these developments with increased vigilance. ECB President Christine Lagarde stated that the central bank is prepared to act decisively if energy-driven inflation persists, outlining scenarios where inflation could reach up to 6.3% in a severe case, compared to a baseline of 2.6%. However, she emphasized that policy decisions will depend on the clarity and persistence of the energy shock, and no imminent move is currently signaled by market pricing [2]. ABN AMRO economists, however, expect a more hawkish ECB response, projecting two rate hikes in Q2 (April and June), which would bring the deposit rate to 2.50%. They forecast inflation to rise well above the 2% target from March, peaking above 3% in the coming months, and anticipate only gradual easing by 2027, with the deposit rate returning to 2% after two cuts in early 2027 [4].
The energy shock is also affecting the Eurozone’s growth outlook. ABN AMRO has significantly downgraded its growth forecasts, citing weaker household and business confidence and higher near-term interest rates. The bank expects higher food and energy-intensive goods prices to add further upward pressure on inflation [4]. According to BNY’s Bob Savage, the Euro faces conflicting forces as the ECB balances inflation control with fragile economic activity, and investors are reassessing the risks [2].
In Australia, the impact of higher energy prices is also evident. February’s headline CPI was slightly softer than expected at 3.7% year-on-year, but Brown Brothers Harriman’s Elias Haddad expects inflation to accelerate as energy costs feed through. The Reserve Bank of Australia (RBA) has warned that inflation risks have tilted further to the upside, with markets pricing a 65% chance of a 25 basis point rate hike to 4.35% at the May 5 meeting, following the release of Q1 CPI data on April 29 [3].
CONCLUSION
The surge in energy prices has triggered a hawkish shift in ECB policy expectations and dampened growth prospects in Germany and the broader Eurozone, with significant inflationary pressures anticipated in the coming months. While fiscal stimulus may cushion some downside risks in Germany, central banks in both Europe and Australia are signaling readiness to tighten policy further if inflation persists. Market sentiment remains cautious amid ongoing geopolitical uncertainty.