Eurozone Business Activity Contracts as Services Slump on War Impact

Business activity across the euro area declined in April, marking the first contraction since late 2024 as the services sector weakened sharply under pressure from the Middle East conflict. The S&P Global Composite Purchasing Managers’ Index fell to 48.6 from 50.7 in March, undershooting expectations and dropping below the 50 level that signals growth.

The downturn reflects a rapid shift in economic momentum. Analysts had expected only a marginal slowdown, but rising energy costs and weaker consumer demand linked to the Iran conflict appear to have hit service industries more quickly than anticipated.

Services Sector Decline

The services sector drove the decline, reversing earlier gains and dragging the broader private sector into contraction. In contrast, manufacturing showed relative resilience, with some countries even exceeding forecasts despite the broader slowdown.

Germany followed that pattern, with industrial output holding steady while services activity dropped sharply. France offered a partial offset, where factory output reached its strongest level since 2022, though services there also deteriorated.

Disrupted Recovery Outlook

The eurozone had entered 2026 expecting a gradual recovery supported by easing inflation and improved industrial output. That outlook has been disrupted by the surge in energy prices tied to the conflict involving Iran, which has raised costs for businesses and reduced household spending power.

At the same time, supply constraints linked to the conflict are beginning to emerge, adding another layer of pressure. These disruptions risk extending the economic impact beyond energy markets into broader production and trade channels.

ECB Concerns

The contraction is likely to sharpen concerns at the European Central Bank. Inflation has already moved well above the bank’s 2% target, driven in large part by energy costs, while growth is now showing signs of faltering.

Despite the weaker data, the ECB is expected to hold interest rates steady at its upcoming meeting as it assesses whether the rise in prices will persist. Financial markets are currently pricing in two rate increases before the end of the year, reflecting ongoing concern about inflation.

Government Response

Higher energy costs are weighing on both consumers and businesses, limiting output at a time when the economy had been expected to strengthen. Service industries, which are more sensitive to consumer demand, are bearing the brunt of the slowdown.

Governments are beginning to respond. Several countries are introducing support measures to offset rising fuel costs, while large-scale spending plans—particularly in Germany—focused on defense and infrastructure are expected to provide some economic support.

Uneven Recovery

The divergence between manufacturing and services highlights an uneven recovery that could complicate policy decisions. While industrial sectors may benefit from government spending and export demand, services remain vulnerable to shifts in consumer confidence.

The situation also underscores Europe’s exposure to external shocks, particularly in energy markets. As long as prices remain elevated, the region’s growth prospects are likely to remain constrained.

Future Risks

The key uncertainty is how long the current energy shock will last and whether supply disruptions intensify. Prolonged pressure could deepen the downturn and force more aggressive policy responses.

At the same time, inflation remains a competing risk. If price pressures continue to build even as growth slows, the ECB could face a difficult trade-off between supporting the economy and controlling inflation.