Ifo Institute warns of rising inflation due to Middle East conflict

The researchers at the Munich Ifo Institute expect prices to rise sharply as a result of the Iran war. The cost of living is likely to be 3.0 percent higher in 2027 than 2.8 percent in 2026, as the researchers predicted.

"The longer the war in the Middle East lasts and energy prices remain high, the more consumer prices for food, services and goods are likely to rise in the medium term," said Ifo researcher Tiphaine Wibault. The reason for this is that companies are allowed to pass on increased costs with a delay.

Inflation in Germany rose sharply again in August due to expensive energy. According to the Federal Statistical Office, goods and services cost 2.9 percent more than in the same month last year. Consumer prices last rose even more strongly at the end of 2023. In July, the inflation rate climbed to 2.8 percent, from 2.3 percent in June. The biggest price driver remained energy, which cost significantly more due to the renewed Middle East war. Special effects such as low water on the Rhine also impacted many consumers - for example in North Rhine-Westphalia.

Inflation in the euro area at 3.3 percent

In the euro area, inflation has already increased even further. Consumer prices here rose by 3.3 percent in August, after 2.9 percent in July, as the EU statistics office announced based on preliminary data.

Against the backdrop of the Iran war, energy in particular once again proved to be a price driver: it rose by 14.3 percent in August compared to the same month last year. The European Central Bank is targeting overall inflation at 2.0 percent.

Despite this situation, there could be at least a slight relaxation in this country temporarily. According to the Ifo researchers, slightly fewer companies planned to increase their prices in August. The corresponding barometer for price expectations fell to 21.2 points, after 21.6 points in July. "This suggests that price pressure will ease slightly over the next three months."

However, crude oil prices and especially the market prices for natural gas and electricity have risen significantly again since the beginning of August. Recently there have been increasing signals that the monetary authorities at the European Central Bank (ECB) could counteract price increases by increasing interest rates.

In the entire euro area, the upward risks for inflation have recently increased again, said the head of the Austrian central bank, Martin Kocher: "If this picture is confirmed in the next ECB forecast, I consider a further interest rate increase in the near future to be necessary."

Higher interest rates expected in September

According to Kocher's Finnish colleague Olli Rehn, the ECB has to prepare for a protracted conflict in the Middle East, which could keep inflation in the euro area high. “In view of this inflationary pressure, we must not be lulled into security,” the ECB Governing Council member told the Financial Times.

Thomas Gitzel, chief economist at VP Bank, already expects the ECB to raise its key interest rates by 25 basis points. “The monetary authorities should see an inflation rate of over three percent as a mandate,” he said. However, there is also “a fear that the higher energy prices will also lead to an increase in the price of other goods.”

The oil price shock could permanently disrupt the price structure. Due to the high energy costs, there is also a risk for consumers and companies that a wage-price spiral will occur and that strong inflation will become entrenched.

The next interest rate decision is due at an external meeting on September 10th in Berlin. On the financial markets, the deposit rate, which is used to control monetary policy, is expected to increase by a quarter point to 2.50 percent. The ECB recently took a break from interest rates after showing its flag in the fight against rising inflation in June with the first increase in three years.