Europe: Iran's war affects consumption

Household spending in the euro area fell sharply during the first weeks of the Iran war, as consumer confidence declined and concerns about inflation and income intensified, according to an article published by the European Central Bank (ECB) in its economic bulletin. The ECB warned that any further escalation of the conflict could prompt households to cut spending again, threatening private consumption, a key driver of the euro area economy, which has been weak for years. Consumer confidence dropped sharply after the outbreak of the war, before registering a limited recovery later, but remained well below pre-conflict levels. ECB data showed that nominal consumption growth slowed to about 2.5 percent year-on-year in April, compared to an average of 3 to 4 percent since mid-2024. Nominal consumption reflects the value of spending at current prices, meaning that its increase does not necessarily reflect a rise in the volume of goods and services purchased by households, especially amid rising prices. The ECB said that the decline in consumption in April was similar in magnitude to households' reaction to the outbreak of the Russian war in Ukraine in early 2022. Most of the drop in spending resulted from high-income households reducing their purchases of non-essential goods and services, rather than from a direct decline in their spending capacity. These households have more room to delay buying luxury goods when uncertainty rises, unlike low-income households, whose spending is concentrated on basic needs such as food, housing, and energy. This behavior suggests that the decline in consumption was primarily driven by a loss of confidence and fear of the war's economic repercussions, rather than an immediate drop in incomes. Rising energy prices after the war's outbreak increased consumers' fears of accelerating inflation and eroding purchasing power, even before the full impact of higher costs on goods and services prices became apparent. An earlier ECB study showed that consumers raised their inflation expectations for the following year by about 2.5 percentage points on average in March, while lowering their economic growth expectations by about 1.2 percentage points. Nearly 40 percent of ECB survey participants believed that real income losses caused by rising prices would not be compensated in the future, explaining the increased caution and tendency to delay spending. Continued weak confidence means that consumption improvement will remain fragile, while renewed fighting or higher energy prices could quickly push households back toward saving and cutting non-essential purchases.