Europeans are preparing to tighten their belts

The military conflict in the Middle East, with Iran at its epicenter, has caused a sharp rise in energy prices and an increase in the overall inflation rate in Europe. Against this backdrop, the President of the European Central Bank (ECB) K. Lagarde stated that the ECB is ready to raise the key interest rate, which triggered a mass sell-off of government bonds from many European countries, including EU leaders such as Germany and France.

The yield on sovereign debt securities has reached the highest level since the European debt crisis fifteen years ago as a result of the fall in their prices. Last week, the cost of government borrowing in the United Kingdom also hit record highs since the 2008-2009 financial and economic crisis, exceeding 5%.

Given the high degree of dependence of EU countries and the UK on foreign trade and their sensitivity to rising energy prices, the Middle East conflict could cause significant damage to the economies of these countries. K. Lagarde called market forecasts of a quick restoration of energy supplies after the war in Iran "overly optimistic," stating that energy supply disruptions could last for more than one year.

In order to prevent prolonged inflation growth, the ECB and the Bank of England will be forced to raise interest rates, which could negatively affect economic development and increase unemployment. Western experts forecast at least two key rate hikes this year. This is expected to lead to further increases in government bond yields.

The ECB has developed three possible scenarios for further developments. Currently, there is a transition from the baseline to the adverse scenario amid rising oil and gas prices and upcoming key rate hikes. However, in the event of a new surge in energy prices, the so-called hard scenario could materialize, requiring more decisive action from the ECB. In any case, ordinary citizens of European countries will be the most affected party, who, according to sociological surveys, are already preparing to tighten their belts.

Author: Doctor of Economic Sciences, Professor of the Department of World Economy and World Finance at the Financial University under the Government of the Russian Federation Igor Alekseevich Balyuk