ECB outlines euro area economic outlook with adverse scenarios

Philip R. Lane, Member of the Executive Board, presented the ECB's outlook for the euro area economy. The presentation detailed baseline and adverse scenarios, focusing on energy supply, inflation, and growth projections.

Three paths for the euro area economy

The European Central Bank's economic outlook for the euro area outlines a baseline and two alternative scenarios: adverse and severe.

The baseline assumes no explicit duration for conflict or energy infrastructure destruction, with energy prices following March 11, 2026, technical assumptions.

Uncertainty, measured by the VIX index, sees a limited upward adjustment.

The adverse scenario projects acute energy supply disruptions without significant further infrastructure damage, alongside a 10-point VIX increase with a fast reversal.

This leads to stronger impacts on food, goods, services, and wages due to non-linearities observed after the 2021-22 energy episode.

The severe scenario anticipates even more acute energy disruptions and significant infrastructure destruction, with a 14-point VIX increase remaining elevated until end-2027.

This path implies sizeable indirect and second-round effects on inflation due to stronger non-linearities.

All scenarios assume no fiscal or monetary policy reactions beyond those already included in the baseline.

Growth and inflation under pressure

Simulations using the ECB-BASE model reveal the potential impacts of these scenarios on the euro area economy.

Under the adverse scenario, real GDP growth is projected to deviate negatively from the baseline by approximately 0.4 percentage points in 2026, with HICP inflation showing an upward deviation of around 0.5 percentage points.

The severe scenario presents a more pronounced impact, with real GDP growth deviating by over 0.6 percentage points and HICP inflation by more than 1.0 percentage point in 2026.

HICP excluding energy and food inflation also shows upward deviations, albeit smaller, reflecting the broader pass-through effects.

These simulations incorporate energy, uncertainty, and trade effects, with uncertainty shocks on GDP estimated using an empirical BVAR model.

The analysis underscores the significant downside risks to economic activity and upside risks to inflation stemming from geopolitical tensions and energy market volatility.

Geopolitical risks loom large

This comprehensive scenario analysis serves as a stark reminder of the euro area's vulnerability to external shocks, particularly from energy markets and geopolitical tensions.

While the baseline remains the most likely path, the significant deviations projected under adverse and severe conditions highlight the persistent upside risks to inflation and downside risks to growth.

Policymakers must remain vigilant, as the potential for non-linear effects from energy shocks could quickly destabilize the disinflationary process.