Central Bank Warns Middle East Conflict Could Push 2027 Inflation to 5%

The Central Bank has revised its inflation forecasts upward, warning that continued conflict in the Middle East could push inflation to 5% in 2027, primarily driven by energy prices. The US-Israeli war against Iran began on February 28 with the killing of Ayatollah Ali Khamenei. Talks to end the conflict are scheduled to begin on Friday.

Despite optimism from oil prices dropping below $80 (€69) a barrel on Tuesday due to the promised reopening of the Strait of Hormuz, Robert Kelly, the Central Bank’s director of economics, noted that restoring supply chains and resolving production cost impacts will take time. The Central Bank emphasizes balancing support for vulnerable populations with enabling households and firms to build resilience.

Modified domestic demand (MDD) growth, influenced by multinational investment in AI and data centers, increased in Q2 and is expected to continue growing, albeit slower, despite rising energy costs eroding real household incomes. GDP contracted last quarter due to volatile exports of GLP-1s, with demand for weight-loss injections expected to slow year-on-year.

The Central Bank’s baseline inflation projections are 3.5% for 2026 and 2.9% for 2027. In an adverse scenario, oil and gas prices could rise by 10% and 14% above baseline, respectively, until late 2028, increasing inflation by 0.3 percentage points. A protracted conflict could see oil and gas prices rise 32% and 63% above the 2026 baseline, pushing inflation towards 5% in 2027 and significantly slowing growth. The report also highlights risks of broader supply chain disruptions, such as price increases in fertilizers and helium, and potential wage increases by workers to offset real income losses, which firms might pass on to consumers. The seasonally-adjusted unemployment rate reached 5% in Q1 2026, up from 4.6% in Q4 2025, the highest since late 2021.