Persistent energy pressures are pushing eurozone inflation back above target just as economic activity struggles to gain momentum, leaving the European Central Bank increasingly likely to raise interest rates again in September.
Europe is confronting an uncomfortable combination of stubborn inflation and weak economic growth, reviving fears that the continent could enter a prolonged period in which policymakers are forced to fight rising prices without the support of a strong expansion.
The European Central Bank is now widely expected to raise interest rates again in September, with a Reuters poll published on August 13 showing that 83% of economists surveyed anticipate a quarter-point increase in the deposit rate to 2.50%. If delivered, the move would mark another step in the ECB’s renewed tightening cycle, driven largely by the resurgence of energy-related inflation.
The challenge is particularly delicate because the eurozone economy remains far from robust. Growth has been uneven across the bloc, while investment and household consumption continue to face pressure from higher borrowing costs, weak confidence and elevated energy bills. The ECB’s latest projections foresee euro-area GDP expanding by only 0.8% in 2026, before accelerating modestly to 1.2% in 2027.
At the same time, inflation has moved in the wrong direction. Eurozone consumer-price growth reached 2.9% in July, according to the latest estimates cited by Reuters, remaining well above the ECB’s 2% objective. The principal source of renewed pressure has been energy, with oil prices rising sharply amid continued geopolitical instability in the Middle East.
The European Commission had already warned earlier this year that the energy shock could significantly alter the region’s economic trajectory. Its spring forecast projected euro-area inflation averaging around 3.0% in 2026, compared with an earlier expectation of 1.9%, while growth was expected to slow markedly.
For European households, the consequences are increasingly visible. Higher energy prices feed directly into electricity, heating, transportation and food costs, while tighter monetary policy increases the expense of mortgages, corporate credit and consumer loans. The result is a squeeze on disposable incomes at precisely the moment governments are attempting to encourage stronger domestic demand.
Businesses face a similar dilemma. Manufacturers remain exposed to elevated energy costs, particularly in Germany, Italy and other industrial economies, while financing conditions have become less favourable as interest rates rise. Investment has already weakened in parts of the euro area, and the ECB has acknowledged that domestic demand has lost momentum, with construction investment among the areas showing particular softness.
Yet the picture is not uniformly negative. European financial markets have remained comparatively resilient. The pan-European STOXX 600 edged higher on Monday, supported by gains in technology and basic-resource stocks, while Goldman Sachs recently raised its 12-month target for the index, citing solid corporate earnings and the relative resilience of the European economy.
This resilience, however, does not remove the central policy problem. The ECB must decide whether allowing inflation to remain above target poses a greater long-term risk than tightening monetary conditions further in an economy already expanding only modestly.
The situation is further complicated by growing divergence between the world’s major central banks. While investors increasingly expect the ECB and the Bank of Japan to raise rates, weaker consumer data in the United States has strengthened expectations that the Federal Reserve could remain on hold. That shift has recently supported both the euro and the British pound against the dollar.
Europe also faces structural vulnerabilities that extend beyond monetary policy. Productivity growth remains weak, demographic pressures are intensifying, and exporters continue to lose global market share in several sectors. ECB projections suggest that external demand will remain constrained by competitiveness problems even as domestic investment struggles to regain momentum.
Adding to those difficulties, extreme weather is increasingly emerging as an economic risk in its own right. Severe heat and drought across parts of Europe this summer have disrupted agriculture, river transport, energy production and industrial supply chains, increasing concerns that climate-related shocks could become another persistent source of higher costs and lower productivity.
The eurozone therefore enters the final months of 2026 in a precarious position. It is not in recession, financial markets remain functional and employment conditions have so far provided a degree of stability. But the economic environment is becoming increasingly unforgiving.
If the ECB raises rates in September, it will be betting that controlling inflation now will ultimately protect household purchasing power and economic stability. The risk is that another tightening move could further suppress investment and consumption before Europe has achieved a convincing recovery.
The coming months will show whether the region can absorb that pressure — or whether its renewed battle with inflation will come at the cost of another year of disappointing growth.
