Europe Defies Expectations Amid Iran War

As the Iran War reaches its six-month mark, Europe has defied expectations by faring much better than predicted. Growth has remained steady, and inflation hasn't skyrocketed as some anticipated.

The war's impact on energy prices has been significant, with natural gas contributing around 25% of eurozone inflation in July compared to a whopping 4% at the same point in 2022. However, this has yet to translate into broader price increases across other areas of the core inflation basket.

An index created by the ECB shows energy-sensitive inflation barely budging, and even decreasing for some items such as air fares and courier costs. This suggests that while the war's effects are being felt, they are not as widespread or severe as initially feared.

Despite this, central bank hawks remain concerned about upside risks to inflation. They point out that energy-sensitive prices tend to lag behind energy price changes by six months, suggesting that we may yet see higher inflation rates in the coming months.

However, food inflation has been trending down, and is virtually zero in some regions. This should reassure hawks at the ECB and Bank of England, as lower food inflation tends to indicate lower consumer expectations.