By Jan Strupczewski
NICOSIA, May 22 (Reuters) - Europe's economy is in a stagflationary trend due to the surge in energy prices caused by the Iran war, but governments must not allow support measures to trigger a fiscal crisis, EU finance ministers said on Thursday.
The European Commission forecast on Thursday that euro zone economic growth will slow to 0.9% in 2026 from 1.3% in 2025 and inflation will jump to 3.0% from 1.9%, well above the European Central Bank's target of 2.0%.
"There is stagflationary
pressure, but Europe is resilient," the chairman of euro zone finance ministers Kyriakos Pierrakakis said before entering informal ministerial talks in Nicosia.
The effects of the Middle East war could be worse depending on how long it lasts, the Commission said.
Investors have started worrying that the war in Iran may cause a lasting inflationary shock and yields of government bonds rose to decade highs, threatening a severe hit to the spending power of governments, businesses and households.
"We have seen the instability in the bond markets and we are trying to balance on the one hand the need to support our citizens ... and on the other we should not allow this energy crisis to metastasize into a fiscal crisis," Pierrakakis said.
GOVERNMENTS NEED TARGETED MEASURES
The European Commission called on governments to only use targeted and temporary fiscal support for the most vulnerable groups, but many countries, wary of voter displeasure, have already put in place measures like excise tax cuts on petrol, that are the same for all.
"In terms of policy response we recommend to stick to temporary and targeted measures, not to sustain and drive up demand for fossil fuels in view of the limited fiscal space," European Economic Commissioner Valdis Dombrovskis said.
"What we need to be is surgical (with the support measures)," Pierrakakis added.
The Commission forecast that the aggregated euro zone budget deficit will rise to 3.5% of GDP next year from 2.9% in 2025, above the 3.0% EU limit, and public debt is to rise to 91.2% in 2027 from 88.7% in 2025.
Some governments, like Italy, are pushing for the European Commission to exclude government fiscal support to fuel prices from EU deficit calculations, similarly to spending on defence, but neither the Commission nor most finance ministers want that.
"I know some countries are proposing this, but opening a general escape clause is difficult because this is a supply crisis, rather than a demand one," Belgian Finance Minister Vincent van Peteghem told reporters.
(Reporting by Jan Strupczewski; Editing Chiara Rodriquez)
