Economic Buzz: Prolonged period of high energy prices will continue to weigh on European economy, says IMF

International Monetary Fund or IMF noted in a latest update that European economy continues to be affected by continuing war on Ukraine and the prolonged war in the Middle East. Europe has weathered the initial impact of the latter far better than feared. One factor behind this is progress towards the energy transition with the adoption of renewable energy, reducing reliance on imported fossil fuels.

It stated that growth is lower than expected before the war, but not as low as we feared last time around. Headline inflation has risen markedly, but underlying inflationary pressures remain broadly contained so far, but Europe is not yet out of the woods. The prolonged period of high energy prices will continue to weigh on the economy, and sovereign yields are rising in many countries, uncertainty is still quite high, so growth is set to remain fragile and mediocre.

In the euro area, excluding Ireland, growth is expected to be 1.2 percent in 2026 before decreasing slightly to 1.1 percent in 2027. This is low growth, but unfortunately also broadly at the level of potential of most European advanced economies. In Central, Eastern and Southeastern Europe, growth in 2026 is projected to be 2.2 percent before picking up modestly in 2027, and this compares with around 3.5 percent on average in the previous two decades. As for inflation, the fund expects it to remain above target in the euro area until 2028 and for even longer in some of the Central and Southeastern European countries.

According to the IMF, in such an environment, macroeconomic policy needs to tread carefully and guard against inflationary pressures becoming entrenched. Monetary policy may need to do more in some countries and stay restrictive for longer to keep inflationary pressures contained.

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