Europe's economy is feeling the mounting strain of an energy shock triggered by the war in Iran, with fresh data showing the eurozone shrinking at its sharpest pace in over two-and-a-half years while inflation climbs to levels not seen in years. The disruption centres on the Strait of Hormuz — the narrow waterway between Iran and the Arabian Peninsula through which roughly a fifth of the world's traded oil and gas passes — where ongoing conflict has severely curtailed shipping, sending fuel prices sharply higher across the continent.

The S&P Global Flash Composite Purchasing Managers' Index for the eurozone fell to 47.5 in May, down from 48.8 in April and its lowest level since October 2023. Any reading below 50 signals contraction. Services activity — the dominant driver of the eurozone economy — fell to 46.4, its weakest since February 2021, while new orders dropped at their fastest pace in 18 months. Companies cut jobs for a fifth consecutive month, with the pace of redundancies the steepest since November 2020. In Germany, Europe's largest economy, the central bank the Bundesbank reported that inflation is trending upward and growth will likely be flat in the second quarter. The European Commission has now halved its growth forecast for Germany to 0.6 percent for the current year, while its eurozone-wide projection has been cut from 1.2 to 0.9 percent. Under a worst-case scenario — in which energy prices do not peak until late 2026 — those figures could roughly halve again, EU Economy Commissioner Valdis Dombrovskis warned, calling on member states to reduce their dependence on imported fossil fuels.

Adding to the pressure, European gas storage levels stand at just above 35 percent capacity, well below the seasonal norm of around 50 percent, according to Gas Infrastructure Europe. Senior executives at Norwegian energy company Equinor warned that if Hormuz shipping disruptions persist for another one to three months, Europe could face a critical shortfall heading into winter. Eurozone inflation held at 3.0 percent in April — above the European Central Bank's 2.0 percent target — and the Commission now projects it could reach that level by year's end, far above its earlier forecast of 1.9 percent. The ECB, which left rates unchanged last month, is widely expected to raise them in June, though analysts caution that deepening economic weakness may force a pause thereafter.

Governments are scrambling to cushion consumers from the blow. France announced an additional €710 million in relief measures, bringing total fuel-related support to nearly €1.2 billion. The package includes doubling a tax-free fuel allowance that employers can pay to staff who drive to work, from €300 to €600, as well as increased mileage reimbursements for home-care workers and public servants, and extended subsidies for farmers and fishing fleets. Prime Minister Sébastien Lecornu ruled out a blanket fuel tax cut, arguing support must remain targeted at those most in need, while warning that the Middle East conflict would last