Europe's economy is holding up better after the Iran war shock than in 2022

When the Iran war broke out in February, the immediate reflex across European policy circles was to reach for the playbook written after Russia's invasion of Ukraine in 2022. The comparison was understandable but, as the second quarter's growth figures now confirm, it was also misleading. Europe has absorbed this energy shock with considerably more resilience than most analysts anticipated.

Growth figures that confounded expectations

The data released in recent days tell a clear story. The United Kingdom's economy expanded by 0.4% quarter on quarter in the three months to June, following 0.6% growth in the first quarter. The euro-zone matched that 0.4% figure. Strip out Ireland's notoriously volatile GDP, and the currency bloc still managed 0.3%, unchanged from the first quarter. Poland, often a bellwether for central Europe, grew at 0.9%.

These are not blockbuster numbers, but they are a long way from the contraction that many feared when oil prices spiked after the outbreak of hostilities. The question is not whether Europe is booming; it plainly is not. The question is why it has not buckled.

Why the 2022 comparison fell short

The instinct to look back four years was natural. Russia's invasion of Ukraine sent European natural gas prices to extraordinary levels, triggered an energy rationing debate, and pushed several economies to the brink of recession. The Iran war also disrupted energy markets, but the scale of the price shock has been significantly smaller. Brent crude rose, but not to the peaks of 2022. More importantly, European natural gas prices, while elevated, have remained well below the spikes that accompanied the loss of Russian pipeline supplies.

Part of that moderation reflects changes in the market itself. Europe has spent the intervening years building LNG import capacity, diversifying suppliers, and filling storage facilities earlier in the season. The infrastructure that was scrambled into service in 2022 is now operational and routine.

The energy transition's quiet contribution

Less visible, but economically significant, Europe has reduced its structural dependence on fossil fuels. Renewable generation has increased its share of electricity supply over the past three years. Energy efficiency investments, many driven by EU directives and national programmes, have also reduced demand. The cumulative effect is striking: euro-zone oil imports by volume have fallen roughly 10% compared with 2022, and natural gas imports by close to 15%.

Those percentage reductions mean that even when prices rise, the total drag on national income is smaller. Calculated as the annual change in the cost of oil and natural gas imports as a share of euro-zone GDP, the growth drag this year is a fraction of what it was in 2022. International Energy Agency data on European gas demand confirm the structural decline in consumption.

Fiscal and credit cushions

Demand-side factors have also helped. Fiscal policy across the euro-zone has become more supportive. Structural budget deficits have widened, partly through energy support programmes that subsidise household and business costs, partly through increased defence spending driven by the security implications of the Iran conflict, and partly through the ongoing drawdown of the European Union's NextGenerationEU recovery funds. The fiscal expansion is modest in aggregate, but it has provided a floor at a moment when private demand might otherwise have faltered.

Bank lending has also picked up, particularly to non-financial corporations. After more than a year in which tight ECB monetary policy appeared to be constraining credit, the latest data show net lending to companies turning positive again. European Central Bank lending statistics confirm that the credit squeeze that characterised 2023 and early 2024 has eased.

Household saving and the inventory effect

Two further factors have supported activity in the second quarter. European households entered the year with saving rates above their pre-pandemic norms. As energy prices rose, consumers chose to run down some of those savings rather than cut spending proportionally. The saving rate has declined from its early-2026 level, cushioning the hit to consumption.

There is also evidence that manufacturers brought forward production in the second quarter, anticipating further energy cost increases later in the year. If correct, this means some of the Q2 output was borrowed from future quarters, and inventory accumulation may have risen as a result. The data on stocks has not yet fully reflected this, but the risk is that part of the second quarter's strength is a timing shift rather than a genuine acceleration.

The paradox of energy-intensive industry

Perhaps the most surprising development has been the resilience of energy-intensive industry. In 2022, sectors such as chemicals, metals and glass were hit hardest. This time, production has held up. The explanation appears to lie in refining. Production of refined energy products has been strong because the spread between crude oil input costs and refined product prices has widened. Crack spreads, as they are known, have boosted margins for refiners, making the energy-intensive sector look healthier on aggregate even though the underlying demand story may be more mixed.

This is an important nuance. The aggregate resilience of energy-intensive industry does not necessarily mean that every subsector is thriving. Refiners have done well because margins expanded. Other heavy users of energy may still be struggling, but their weakness is being masked by the strength of refined product output.

What the second half holds

The expectation among economists tracking the region is that growth will slow in the second half of the year, but not collapse. Forecasts put UK quarterly growth at roughly 0.2% in both the third and fourth quarters, with the euro-zone slightly ahead at around 0.25%.

Two forces will weigh on consumption. Inflation has further to rise, particularly in the United Kingdom, where household utility contracts price energy costs on a longer lag than the continental system of immediate pass-through. British consumers will feel the full effect of higher wholesale prices later than their European counterparts, which means the squeeze on real incomes will persist into the autumn and winter.

The UK also faces a specific domestic risk. The Budget scheduled for October is widely expected to include tax increases, and uncertainty about the scale and targeting of those measures may already be causing households to defer spending decisions.

Risks that have not gone away

None of this means the threat has passed. A further escalation in the Iran conflict could push oil and gas prices far higher, overwhelming the structural improvements Europe has made. The region's deeper problems also remain. Productivity growth is weak across the continent, and the boost from artificial intelligence that has lifted US investment and output is barely visible in European GDP figures. The information and communications technology sector in the UK has been strong, but much of that reflects media and marketing spending tied to the football World Cup rather than a sustained AI-driven investment cycle.

China's industrial upgrading poses a separate challenge. As Chinese firms move further up the value chain, they compete more directly with the advanced manufacturing sectors that European economies, particularly Germany's, have long relied upon. That pressure will persist regardless of what happens in the Middle East.