The ongoing Middle East conflict is muddying the macroeconomic outlook for Europe, with the risk of a dramatic shock later in the year if the Strait of Hormuz continues to remain closed. On top of that, a widening consumer wealth gap, concerns of AI-driven job insecurity, and potential food inflation are further complicating the region’s outlook.
In an exclusive fireside chat, James Pomeroy, Global Economist at HSBC, sat down with AlphaSense’s Julia Lecocq, SVP of Corporate Sales & UK Country Manager, to share his views on the current economic backdrop in Europe, as well as the risks and opportunities that lie ahead for the region. Below, we recap the key takeaways from that discussion.
Impact of the Middle East Conflict
The biggest risk for the European economy is the duration of the Middle East conflict, which will continue to do more damage to the economy the longer it drags on. For now, Pomeroy notes that consumers are feeling the effects mostly through rising gas prices. However, from his conversations with other business leaders, he believes there are rising input costs in supply chains that businesses have yet to pass on to consumers.
I get the sense that there's this huge cost inflation in supply chains for a lot of businesses right now, but there's a reluctance to pass that on yet. And so the initial shock has been very much an input cost shock for businesses, not necessarily a sort of broad-based inflation spiral.
Pomeroy continued that the risk to the economy grows greater the longer the conflict goes on and the Strait remains closed, because inflation will continue to build and hit consumer confidence, resulting in weaker economic growth.
The question is, when does it start to hit and when does it start to impact the economy? So it's an odd sort of answer, but it's sort of like the impact so far has been quite small, but the impact over the next five or six months could be quite dramatic.
Rising Inflation
Food inflation is likely to become a problem for European households due to rising prices of fertilizer and other production inputs from the geopolitical conflict. Pomeroy’s team calculated food prices could rise as much as 20% over the next year, on the back of increasing shipping costs and fertilizer prices. The Persian Gulf is a major producer of fertilizer, so the closure of the Strait of Hormuz has directly affected the availability of a key component of food production.
It still really hurts European economies because people really, really hate food inflation. You have got no choice. If energy inflation goes up, you could not drive, you could not heat your home. Food inflation, you still have to buy food. And the challenges with this sort of nature of food inflation is likely to be pretty universal. Almost everything we buy is involved in one of those components that's gone up in price.
Monetary policy in response to fuel and food inflation will also influence the extent to which these rising costs will impact the economy. Pomeroy’s team expects the Bank of England to raise rates two times this year and for the European Central Bank to raise it three times. But in Pomeroy’s view, rate hikes won’t solve the central issue, which is the closure of the Strait of Hormuz. Instead, he argues the rate hikes will ripple through the economy and suppress demand.
When it comes to fiscal support, Pomeroy expects the European government response will be relatively muted compared with their response during the pandemic. Many European governments are facing large fiscal deficits along with an increase in defense spending. At the same time, Europe is suffering from an aging population that continues to weigh on government budgets.
U.K. Capital Influx
Amid the geopolitical turbulence, the U.K. has emerged as one of the most attractive economies to park capital. That’s because the U.K. has been working to keep positive diplomatic ties with major global economic powerhouses, Pomeroy argues, citing recent diplomatic efforts with the EU, China, U.S. and India.
- United States — The U.K. was the first country to achieve 0% tariffs on pharmaceutical exports to the U.S.
- European Union — The U.K. government has been working on resetting relations with the EU and improving post-Brexit cooperation.
- China — The U.K. has emphasized its openness to international trade and is deepening its economic relations with China.
- India — The U.K. and India signed a trade deal in July 2025 with the goal of doubling bilateral trade between the two nations.
London has also emerged as a hotspot for tech and AI companies looking to establish a European presence. Many U.S. tech companies have chosen London for office space, citing skilled, and often cheaper, labor as well as strong government support. Notable AI companies with recent London office openings or expansions include Anthropic, OpenAI and Databricks.
AI in the Labor Market
AI is already affecting the European workforce by contributing to a low-churn labor market, according to Pomeroy. Workers are concerned that AI will soon replace their jobs, which is reducing job mobility and driving wage stagnation. Unease among workers also negatively affects consumption habits, because people who fear for their job are less likely to engage in discretionary spending.
It changes savings behavior because people think, oh, I could lose my job. I'll be a little bit more cautious. And I think that's sort of percolating through the economy. I do also think that in 2026 and potentially next year, AI gives companies the perfect opportunity to lay people off.
For businesses, Pomeroy thinks the implementation of AI will cause corporate profits to rise quickly due to their ability to run leaner operations. And rising corporate profits means a boon for the stock market, he noted.
A Tale of Two Consumers
Europe faces a bifurcated consumer outlook, with higher-income consumers relatively shielded due to rising asset values over the last few years. On the other hand, lower-income consumers with fewer assets have not experienced the same kind of run-up in wealth. They are also more likely to work in jobs that are being affected by AI implementation and feel more pain from fuel and food inflation.
So I do worry about those households, and I worry about the lack of government support for them. And that means the businesses that are exposed to that lower end of the consumer spectrum will feel that pain. At the higher end of the income spectrum, though, this stuff almost doesn't matter. Yes, you've got a bit of food inflation. Yes, you've got some energy inflation, but stock prices are at record highs.
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