France represents a microcosm of the Eurozone economy! The shadow of stagflation looms over, continuously shrinking the policy space of the European Central Bank.

France's unemployment rate unexpectedly rose to the highest level in five years, further indicating that this second largest economy in the eurozone was already in a weak position when the Middle East war broke out. This is also a microcosm of the entire eurozone economy. Data released by the French National Institute of Statistics showed that with the full increase in the number of unemployed people in all age groups, the unemployment rate in the first quarter of this year rose to 8.1%, the first time it has risen to over 8% since 2021, while economists had originally expected the unemployment rate to drop from 7.9% at the end of last year to a slight 7.8%. "The slight increase in unemployment data reflects the economic slowdown," said Franois Villeroy de Galhau, Governor of the Bank of France, on Wednesday. But he also emphasized that we should remember the "long-term progress of the French economy." He pointed out, "During the last economic slowdown period after 2012, the French unemployment rate was over 10%, now it is about 8%. This is obviously not satisfactory news. But since 2010, the net new jobs in the French economy have exceeded 4 million." French Budget Minister David Amiel also said in an interview that these data "remind us that we must continue to advance this top priority." Although the French government successfully handled the budget crisis in February and avoided further political turmoil, the worsening employment market data released on Wednesday still raised concerns. Data released at the end of April already showed that due to weak trade and insufficient domestic demand, the French economy did not grow in the first quarter, falling below economists' average expectations of 0.2% growth. Data showed that in the first quarter, the French economy was constrained by a 0.1% decrease in consumer spending and a 0.7% decrease in household investment; after a stagnation in business investment at the end of 2025, it also decreased by 0.2% in the first quarter. Due to a sharp decline in exports by 3.8%, net trade had a negative impact of 0.7% on GDP. However, inventory accumulation offset this drag, bringing a boost of 0.8%. Chief economist of the Bank of France, Xavier Debrun, said, "The resilience of the French economy is beginning to be tested." "Since the beginning of this year, we have been emphasizing the remarkable resilience of the French economy. And now we are already seeing the first signs of the impact." Market analysts believe that the poor performance of the French economy in the first quarter has weakened the country's annual economic growth target of 0.9%, and the French economy will need to maintain sustained and stable growth in the next three quarters to have a chance to achieve this target. Economists predict that the blockade in the Strait of Hormuz could lead to a 0.3 percentage point reduction in France's economic growth this year. A business survey released by the Bank of France on Tuesday showed that the Middle East war has begun to drag down economic activity and exacerbate inflationary pressures. A survey of 8,500 business executives conducted by the Bank of France showed that industrial and construction activity slowed in April and may decline this month. In the service sector, businesses reported stagnant operations and expect a contraction in May. In addition, the proportion of businesses in various industries raising prices is accelerating, with 13% of industrial businesses reporting difficulties in supply. In the same data released on Wednesday, France's April CPI rose by 2.2% year-on-year, higher than March's 1.7%; and its April harmonized CPI rose by 2.5%, the highest level since July 2024, higher than March's 2%. Analysts generally believe that this surge in inflation in France is mainly due to the recent sharp increase in international energy prices. In April, energy prices in France rose by 14.2% year-on-year, significantly higher than the previous month, with fuel prices such as gasoline and diesel rising particularly sharply. In addition to energy, service prices have also pushed up inflation levels, especially in transportation and accommodation prices. At the same time, the increase in food prices has slowed slightly, while tobacco and industrial product prices have remained stable or slightly decreased. Eurozone economy mired in "stagflation" quagmire, European Central Bank hesitates in dilemma The current situation of slowing growth and rising inflation in the French economy is a microcosm of the entire eurozone economy, which is forcing the European Central Bank onto an increasingly narrow policy path - the central bank is struggling to strike a difficult balance between "raising interest rates to curb inflation or lowering rates to stabilize growth". The inflation situation in the Eurozone is worsening further. The Eurozone's inflation rate surged to 3% in April, the fastest pace since the autumn of 2023, higher than the 2.6% in March. Data showed that in April, energy prices in the Eurozone rose by 10.9% year-on-year, higher than the 5.1% in March. Food and tobacco prices rose by 2.5%, service prices rose by 3.0%, and prices of non-energy industrial products rose by 0.8%. A survey of economists conducted from May 4th to 7th showed that due to the rise in energy prices caused by the Middle East war, the Eurozone's inflation rate is expected to accelerate from 2.8% in the previous survey to 2.9% in 2026. The European Central Bank's own assessment has also revised its 2026 inflation forecast from 1.9% to 2.6%. Analysts predict that to return inflation to the target level of 2% set by the European Central Bank, it will likely not happen until 2028. At the same time, the Eurozone's economic growth prospects are not optimistic. The Eurozone's GDP in the first quarter only grew by 0.1%, lower than expected. Analysts have revised down their 2026 Eurozone economic growth forecast from 0.9% to 0.8%, with growth expected to increase by 1.3% and 1.5% in the following two years. The European economy is currently being impacted by several unfavorable factors such as the US tariffs, weak external demand, etc., and the rise in energy prices will impact industrial transformation in Europe, putting immense pressure on energy-intensive industries. Analysts believe that if the energy crisis persists for a long time, inflation may spread to multiple industries, weakening the momentum of economic growth in Europe, leading the region into a stagflation situation with stagnant growth and high inflation. The European Central Bank announced last month that it would maintain its deposit facility rate at 2%, in line with market expectations. The European Central Bank did not provide guidance on future decisions, reiterating that decisions will be made step by step based on information obtained at each meeting. The European Central Bank's Governing Council stated in a press release: "The upward risks to inflation and the downward risks to growth have intensified. The Governing Council remains in a good position to respond to the current uncertainties." European Central Bank President Lagarde stated at a press conference following the interest rate decision that although policymakers have discussed the option of raising rates and will reassess whether to tighten policy at the June meeting, the current economic situation in the Eurozone should not be labeled as stagflation, emphasizing that it is "completely different" from the situation in the 1970s. Lagarde pointed out that the decision was made with insufficient information, but the Council not only unanimously agreed to keep rates unchanged, but also had a "thorough and comprehensive" discussion on the possibility of raising rates. She said the next six weeks will be an important window to evaluate the economic situation in order to make decisions based on more complete data at the June meeting. Currently, economists expect the European Central Bank to raise rates twice this year - 25 basis points each in June and September, more in line with market expectations for the European Central Bank to act at least twice this year. Regarding the outlook for monetary policy, there are clear differences within the European Central Bank. Earlier this month, ECB Committee Member and Governor of the Slovak National Bank Peter Kazimir said that it is highly likely that the European Central Bank will need to raise rates at the policy meeting in June. Kazimir said that while central bank officials have not committed to a fixed path in advance and need more data to evaluate the impact of the Middle East conflict, "our stance remains firm." He wrote in a column, "Based on this, it is almost inevitable for monetary policy to tighten in June. We must be prepared for persistently rising prices and a clear slowdown in growth across the Eurozone, as this (rate hike in June) is becoming increasingly likely." ECB Committee member and President of the German Bundesbank, Joachim Nagel, said this week that the possibility of the European Central Bank raising borrowing costs is increasing due to the impact of the Middle East conflict. Nagel said, "I still have a glimmer of hope for a significant easing of tensions in the Middle East - but we cannot ignore the high energy prices. Unless there is a fundamental change in the inflation situation, rate hikes are becoming more and more likely." He also warned, "We may still face significant inflation pressure in the future." Nagel acknowledged that the sluggish Eurozone economy may affect decisions next month. He said, "No one likes to raise rates when growth is under tremendous pressure. But our duty is to maintain price stability. In the long run, it is beneficial for everyone if we clearly indicate that we take the inflation target seriously and keep the medium-term inflation rate around 2%. We will fulfill our duty - no excuses." However, some policymakers hold a more cautious stance. ECB Committee Member and Governor of the Bank of Lithuania Vitas Vasiliauskas said, "Obviously, we are discussing the possibility of rate hikes in June. But whether an actual decision will be made will depend on specific circumstances and data." He added that if the Middle East conflict is resolved, "that will be a factor that allows us to consider making other decisions." Franois Villeroy de Galhau said that if inflation spreads beyond the rise in oil prices, the European Central Bank must remain cautious and be prepared to take action on interest rates. He also stated that before any monetary policy tightening, there must be a "sufficient amount" of data on core inflation, wages, and the expectations of businesses and consumers regarding price increases. He also stated that the European Central Bank should consider the possibility that weak demand and slowing economic growth could alleviate inflationary pressures. ECB Vice President Luis de Guindos said that future economic activity data "will not look good." He pointed out that the speed at which energy shocks are reflected in inflation indices is much faster than in growth indicators, and the drag on growth from energy will become more apparent in the coming weeks. De Guindos urged caution in interest rate decisions. He emphasized that even if a ceasefire agreement is reached soon, the conflict will leave "scars" - some infrastructure has been destroyed, and consumer confidence has declined. De Guindos warned, "Key indicators are already declining. The impact of specific factors pushing up energy prices on confidence is sometimes underestimated by us." Overall, the European Central Bank is currently facing a complex policy environment. On the one hand, the escalating tensions in the Middle East are pushing up international oil prices and increasing inflationary pressure in Europe. On the other hand, the slowing economic growth in Europe and the continuous erosion of market confidence are limiting the room for further rate hikes. Risks of the Middle East tension and economic slowdown suppressing the expectation of rate hikes, TD Securities expects the European Central Bank to stay put in June With the ongoing escalation of tensions in the Middle East and international energy prices remaining high, discussions about the future monetary policy path of the European Central Bank are heating up in the market. However, the latest views from TD Securities show that the organization's judgment on the European Central Bank's policy outlook for June is significantly cautious. Unlike some current market expectations, TD Securities believes that the European Central Bank is more likely to maintain rates in June, rather than further hike. TD Securities pointed out that the European economy is still facing pressure from slowing growth, and concerns about the "second-round effects" of inflation in Europe have not completely materialized. The so-called "second-round effects" mainly refer to the further increase in wages, services, and core consumer prices driven by the rise in energy prices, leading to long-term inflationary pressure. TD Securities believes that there are not yet clear signs of runaway wage and core inflation in Europe, so there is a lack of immediate necessity for the European Central Bank to raise rates in the short term. TD Securities states that there may be three different scenarios in the market before the European Central Bank's policy meeting in June. The first scenario is that tensions in the Middle East gradually ease and energy prices fall, reducing temporary inflation pressure in Europe. The second scenario is that the current situation continues to deadlock, with oil prices remaining high, but internal demand in Europe remaining weak. The third scenario is that tensions in the Middle East escalate again, while Europe experiences apparent second-round inflation transfer, with rapid wage and service price increases. TD Securities points out that only the third scenario could truly prompt the European Central Bank to reconsider rate hikes. Currently, the combined probability of the first two scenarios is still higher than 50%. Therefore, TD Securities believes that the European Central Bank is more likely to keep rates unchanged in June and continue to monitor subsequent changes in data, while allowing the currently tightened financial environment to continue to play a role in curbing inflation. Indeed, the financial conditions in Europe have significantly tightened. Financing costs in the Eurozone remain high, business loan demand continues to decline, and the real estate market is also suppressed by high interest rates. At the same time, fiscal pressures in some European countries remain significant, and the high interest rate environment is gradually affecting the cost of government debt financing.