Overview
Deutsche Bank has cautioned that a substantial rise in energy costs stemming from the Middle East conflict could be sufficient to bring the euro zone economy into recession in 2026 and prompt a reversal of the European Central Bank's current easing path. The bank presented two scenarios that contrast a relatively mild price shock with a significantly larger one, and detailed the projected consequences for growth and inflation under each.
Scenario analysis
In the milder of the two cases, Deutsche Bank assumes oil trading at USD 85 per barrel and natural gas at 50 per megawatt-hour - price levels the bank says reflected market pricing as of March 6. Under this scenario the euro area would still experience a material drag on activity: GDP growth in 2026 would be 0.30 percentage points below the pre-conflict baseline of 1.1%. Headline inflation would exceed the baseline by 0.33 percentage points.
The adverse case envisions energy costs roughly 50% higher than the milder scenario, with oil at USD 120 per barrel and gas at 75 per megawatt-hour. Deutsche Bank concludes this larger shock would be consistent with a recession in 2026. Under that trajectory, headline inflation would overshoot the pre-conflict baseline by 1.02 percentage points in 2026 and by 0.44 percentage points in 2027, while GDP growth would be 0.72 percentage points below the baseline in 2026.
Monetary policy implications
Deutsche Bank argues the ECB might be able to "look through" the milder scenario but may be unable to do so if the adverse case materialises. The bank noted that as of March 12 energy prices were closer to the milder scenario.
In terms of market pricing, Deutsche Bank reports that markets are pricing approximately 30 basis points of rate hikes in 2026, compared with roughly 10 basis points of cuts that had been priced before the conflict began on Feb. 28. The bank regards a policy change at the ECB's March 19 meeting as "highly unlikely," but it flagged the possibility of risk-management hikes to 2.5% - a level ECB chief economist Philip Lane identified last year as "clearly restrictive" - which the bank judges could be implemented without materially harming growth.
Forecast updates and outlook
Deutsche Bank expects the ECB's updated staff forecasts - which ECB board member Isabel Schnabel confirmed on March 11 would partly capture the shock - to show headline inflation at 2.3% in 2026, up 0.4 percentage points from the December projections, and GDP growth at 0.9%, down 0.3 percentage points.
Maintaining its baseline view for now, Deutsche Bank has the ECB remaining on hold at 2% through 2026, with the first hike in mid-2027 and rates rising by 75 basis points by the end of 2028, subject to additional clarity on the conflict. The bank also trimmed its German growth forecast to 1.0% in 2026, down from 1.5% previously.
Inflation persistence risks
The brokerage highlighted four specific risks that could sustain higher inflation: the magnitude of the energy price increase, household inflation expectations, the persistence of labour market tightness and fiscal policy responses. On the labour market, the note points out that euro area unemployment remains below the non-accelerating inflation rate of unemployment, and that labour shortages, while easing, "remain far from normal."
Concluding assessment
Deutsche Bank's scenario work frames a clear trade-off: a contained energy-price shock would leave the ECB room to tolerate temporary overshoots in inflation, whereas a larger, sustained energy-price surge would risk tipping growth into contraction and force monetary authorities to adopt a more restrictive stance to anchor inflation expectations. The bank's baseline leaves the ECB on hold through 2026, but the outlook is conditional on the evolving energy-price path and the course of the conflict.