Eurozone Economy Shrank in First Quarter as Iran War Darkens Outlook — 2nd Update

By Ed Frankl

The eurozone's economy contracted in the first quarter, driven by declines in output in Ireland and France, complicating the European Central Bank's task of cooling rising inflation without unduly damaging economic activity.

Gross domestic product in the 21-nation currency area fell 0.2% in the first three months of 2026, the European Union's statistics agency Eurostat said Friday, weaker than the 0.1% growth reported for the period in mid-May.

That marked the first quarter of contraction since October-December 2022, a time when energy prices skyrocketed after Russia's full-scale invasion of Ukraine.

While most eurozone members recorded growth at the start of this year, momentum has weakened in the months since as a result of the war. In new forecasts due at its meeting next week, the ECB may pencil in a contraction in second-quarter activity too.

Investors expect the ECB to raise its key rate by a quarter-point after inflation accelerated above the bank's 2% target due to the conflict in the Middle East.

But some economists argue that the move could be premature at a time the economy is already showing scars from the conflict.

Energy prices rose rapidly after the first U.S.-Israeli strikes on Iran in late February, with Brent crude up more than 30% and European natural gas more than 50% higher. Data published Thursday recorded a retreat in retail sales in April as consumers saw purchasing power decline.

The revision to eurozone growth figures was largely due to a change in the estimate for Ireland. That country's GDP is now calculated to have declined by 12.1% in the first three months of the year, a big change from the 2% contraction that was previously estimated.

Policymakers at the ECB are unlikely to place much weight on the new figures. Ireland's GDP figures are extremely volatile and driven by the activities of a small number of large U.S. businesses based in the country. The country's government said Thursday that it expects GDP to return to growth in the remainder of this year.

Excluding the effect of Irish GDP, eurozone growth would have been 0.3%, although the figure was flattered by inventory stockpiling ahead of impending supply disruption and higher prices, said Rory Fennessy, senior economist at Oxford Economics, in a note to clients.

"Recent batches of both soft and hard data suggest that the worst of the impact on growth from the current supply and inflation shock is yet to come," Fennessy added. "Impending rate hikes by the ECB will add an additional constraint to an already lackluster lending environment."

It will add to the challenge policymakers would face if they decide to raise the key interest rate to contain inflation, since they would be restraining growth at a time when it already appears to be very weak, according to official data.

Private-sector activity fell at its sharpest pace in 18 months in May, according to purchasing managers' index data published this week, as demand for the eurozone's goods and services sank. Input costs rose at the sharpest rate in three-and-a-half years, the report said.

France's data agency also downgraded its GDP to a contraction of 0.1%, from stagnation originally recorded. However, German growth was 0.3% and Spain outperformed at expansion of 0.6%.

Meanwhile, the Organization for Economic Cooperation and Development on Wednesday said it expects eurozone GDP growth of 0.8% this year, a slowdown from 1.4% in 2025 and well behind the around 2% penciled in for the U.S. in 2026.

Write to Ed Frankl at edward.frankl@wsj.com

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Write to Ed Frankl at edward.frankl@wsj.com

(END) Dow Jones Newswires

June 05, 2026 06:28 ET (10:28 GMT)