Euro area economy holding up but prolonged Middle East conflict could have far-reaching consequences

“Given the current environment of heightened uncertainty, there is very good reason why the ECB is not pre-committing to a particular interest rate path but is following a meeting-by-meeting approach to its interest rate decisions and using incoming data and other information,” says Bank of Finland Governor Olli Rehn, who is a member of the ECB’s Governing Council. “So far, we have not seen inflation spread to non-energy prices or wages. But we have to be vigilant, as such effects can creep in unnoticed. The longer the Middle East conflict continues, the bigger the risk that the rise in energy prices will broaden out.”

Cyclical conditions elsewhere in the economy are also relevant to inflation, because if demand is strong, businesses can more easily pass on a proportion of their higher costs to the prices of finished products. The euro area economy has proven resilient, but growth is nonetheless quite subdued.

Two opposing forces at work in global economy

The war in Iran and, on the other hand, the strong investment growth in artificial intelligence (AI) are affecting the economy in opposing ways. While the war is having an adverse economic impact, AI development is supporting economic growth globally, and Europe should use AI adoption to energise its trailing productivity performance. The high market capitalisation of AI companies and their increased leverage are adding to the risk of a market correction.

The increased demand for capital brought by the AI investment boom has raised the price of capital, which has contributed to an increase in long-term interest rates in global financial markets. Other factors behind the recent rise in long-term interest rates are inflation expectations and the rise in public debt. In addition, with the global operating environment becoming more difficult to predict, investors are demanding a higher return on longer term investments.

“The rise in long-term interest rates is contributing to a slowdown in growth and also to a reduction in the pass-through of energy prices to other prices and to wages,” says Rehn.

It is important for the future that the economy has room for manoeuvre to accommodate essential investment in new technologies and in critical defence projects. Government borrowing must be brought onto a sustainable track so that there is scope in the public finances to invest in these areas.

Concern over the rapid rise in public sector borrowing applies extensively to advanced economies, including Finland. In the immediate years ahead, Finland’s obligations under the EU’s excessive deficit procedure will determine the required fiscal consolidation. At the same time, it is nevertheless necessary to take a longer term view and ensure that the public debt-to-GDP ratio can be brought on to a sustainable downward path. “The benefits of the parliamentary commitment to reducing the debt ratio should not be abandoned, nor should the international confidence in Finland’s ability to manage the pressures on its public finances be jeopardized,” says Governor Rehn.

Presentation 6 October 2026, Governor Olli Rehn (In Finnish)

Presentation 6 October 2026, Markku Lehmus (In Finnish)

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