The economic prospects of Europe have significantly deteriorated against the backdrop of energy disruptions caused by the war, which are expected to lead to tighter financial conditions, according to the latest report by the International Monetary Fund, cited by Euronews.
The IMF states that the European economy remains resilient but is increasingly exposed to external shocks, in the context of an energy crisis related to the war in Iran and the closure of the Strait of Hormuz.
The institution calls for swift reforms, including completing the EU's single market through better interconnection of electricity networks, deepening financial integration, and increasing productivity.
Oil prices have risen by about 70%, while gas prices in Europe remain around 45% above pre-war levels. Although less severe than the shock in 2022, these increases are still expected to weigh heavily on economic growth, warns the IMF.
Europe's long-term transition to renewable sources - now accounting for over half of electricity production - has helped mitigate the impact of the energy shock, but the IMF says this offers only partial protection.
Growth forecasts have been revised downwards, with the euro area now expected to grow just over 1% in 2026, compared to around 1.4% before the Iran war, according to IMF estimates. Meanwhile, inflation remains high, reflecting persistent cost pressures from energy and disruptions in supply chains.
Fiscal health depends on the duration of the conflict
The IMF's outlook largely depends on geopolitical developments, with the institution warning that a short-lived conflict in the Middle East could limit the damage, but a prolonged crisis could push Europe into recession.
"The overall economic impact will depend on how the conflict in the Middle East evolves, especially concerning energy supply and infrastructure," said Economy Commissioner Valdis Dombrovskis at a press conference on Monday evening following a meeting of eurozone finance ministers.
He warned that the bloc cannot afford "to repeat past mistakes," emphasizing that any support measures must be temporary, well-targeted, and not boost aggregate demand.
Europe was already facing high energy prices before the U.S.-led war against Iran began to disrupt global energy markets on February 28.
The European industry was paying two to three times more for energy than competitors in the United States and China. This persistent gap reflects a structural vulnerability, not a temporary imbalance, warns the IMF.
Maintain ETS, reform the electricity grid
In this context, maintaining the pace of energy reforms is crucial.
The IMF report urges the EU to remain committed to its carbon market, the Emissions Trading System (ETS), which was on the brink of collapse but is seen by the IMF as supporting continued progress in adopting wind and solar energy.
The institution warns that abandoning the ETS could jeopardize hard-won progress in decarbonization.
Furthermore, Europe must complete its internal energy market, said the IMF, emphasizing that the network package proposed by the Commission in December is "an important step."
A modernized electricity grid and storage capacities are essential for the EU to succeed in the energy transition and will dominate the bloc's decision-making process - and likely political disputes - in the coming months, after Commission President Ursula von der Leyen called on the European Parliament and Council, the EU's co-legislators, to reach a political agreement on the network proposal by summer.
"Made in Europe" could have negative effects
The IMF report also references the Commission's proposal for the Industrial Action Acceleration (IAA), mentioning that it contains useful measures, including efforts to diversify supply chains.
However, it warns that "Made in Europe" procurement rules and conditions on foreign investments related to creating local value could distort markets and weaken comparative advantage.
Protecting strategic industries is a legitimate objective, says the IMF, but it must be guided by a rigorous cost-benefit analysis.
Public policy tools vary significantly in terms of efficiency and costs, and interventions should be limited to situations where markets cannot efficiently adapt on their own.
The report also warns of common pitfalls in public policy, mentioning that relaxing competition rules, pursuing uncoordinated industrial strategies, or scaling back climate commitments could ultimately weaken, rather than strengthen, Europe's position.