UPDATE 1-EU in stagflationary trend, must not risk fiscal crisis, ministers say

European Central Bank President Christine Lagarde told ministers that if they loosen fiscal policy ⁠too much ​to cushion the impact of the energy ⁠prices, the ECB would react with higher interest rates. "We discussed the fiscal response to the energy price shock, and I underlined that fiscal measures should...

Europe's economy is in a stagflationary trend due to the surge in energy prices ‌caused by the Iran war, but governments must be wary that generous fiscal support could risk a fiscal crisis or higher ECB rates, top EU officials said on Friday. The European Commission forecast on Thursday that euro zone economic growth will slow to 0.9% in 2026 from 1.3% in 2025 and inflation ‌will jump to 3.0% from 1.9%, well above the European Central Bank's target of 2.0%. "There is stagflationary pressure, but Europe is resilient," the ‌chairman of euro zone finance ministers Kyriakos Pierrakakis said.

Investors have started worrying that the war in Iran may cause a lasting inflationary shock and yields of government bonds rose to decade highs, threatening a severe hit to the spending power of governments, businesses and households. European Central Bank President Christine Lagarde told ministers that if they loosen fiscal policy ⁠too much ​to cushion the impact of the energy ⁠prices, the ECB would react with higher interest rates.

"We discussed the fiscal response to the energy price shock, and I underlined that fiscal measures should... (be) temporary, targeted and tailored," Lagarde ⁠told reporters after the talks. "Any deviation from those three principles would actually hurt and lead to a different monetary policy stance as a result," she said.

Pierrakakis ​said ministers got the message. "We certainly all understand that we shouldn't contradict monetary policy. Fiscal policy and monetary policy should go hand ⁠in hand," Pierrakakis told a news conference.

GOVERNMENTS NEED TARGETED MEASURES The European Commission called on governments to only use targeted and temporary fiscal support for the most vulnerable groups, but many ⁠countries, ​wary of voter displeasure, have already put in place measures like excise tax cuts on petrol, that are the same for all citizens.

"In terms of policy response we recommend to stick to temporary and targeted measures, not to sustain and drive up demand for fossil fuels ⁠in view of the limited fiscal space," European Economic Commissioner Valdis Dombrovskis said. Some governments, like Italy, are pushing for the European Commission to exclude ⁠government fiscal support to fuel prices from ⁠EU deficit calculations, similarly to spending on defence, but neither the Commission nor most finance ministers want that.

"I know some countries are proposing this, but opening a general escape clause is difficult because this is ‌a supply crisis, rather ‌than a demand one," Belgian Finance Minister Vincent van Peteghem told reporters.