Bank of Portugal Cuts 2026 Growth Forecast to 1.8% Amid Middle East Conflict and Extreme Weather

The Bank of Portugal cut its economic growth forecast for 2026 from 2.3% to 1.8%, marking a significant downward revision driven by the war in the Middle East, surging energy prices, and damage from extreme weather events in early 2026. The central bank also warned of "heightened risks" that the actual outcome could be worse than projected.

The revised forecast, published March 25 in the Bank of Portugal's quarterly Economic Bulletin, reflects what the institution describes as a "deterioration of the external environment" following the US-Israel attack on Iran in late February. The conflict triggered a sharp increase in energy commodity prices, which is having "a negative impact on activity and a positive impact on inflation, especially in 2026."

Why the Forecast Was Cut

The Bank of Portugal identified three primary factors behind the downgrade:

1. Middle East war and energy price shock: The late-February military action against Iran caused oil and natural gas prices to spike. Portugal, like most of Europe, is heavily dependent on imported energy. Higher energy costs feed into transportation, manufacturing, and electricity prices, reducing purchasing power for households and raising input costs for businesses.

2. Extreme weather in January-February 2026: Portugal experienced severe storms during the first two months of the year, causing flooding, infrastructure damage, and agricultural losses. The Bank of Portugal noted that these "extreme weather conditions" directly affected economic output in early 2026 and will weigh on full-year growth.

3. Expected tightening of financing conditions: The central bank observed that economic agents now expect the European Central Bank (ECB) to raise interest rates in response to renewed inflationary pressure from energy prices. Higher borrowing costs would dampen investment and consumption, further constraining growth.

Inflation Forecast Raised to 2.8%

Alongside the growth downgrade, the Bank of Portugal revised its 2026 inflation forecast upward to 2.8%, moving away from the ECB's 2% target. The inflation increase is driven almost entirely by energy prices, which affect not only fuel and heating costs but also food prices (through transportation and processing) and manufactured goods.

The bank emphasized that its forecast assumes the Middle East conflict will have "a relatively limited duration and contained effects on agent confidence and global supply chains." If the war intensifies or drags on, both growth and inflation could deviate further from current projections — growth lower, inflation higher.

Portugal's Growth in Context

Even at 1.8%, Portugal's projected 2026 growth would be respectable by European standards, though below the eurozone average. For comparison:

• Portugal grew 1.9% in 2025 (slightly below the 2.0% previously forecast)
• The eurozone as a whole is expected to grow around 1.5-2.0% in 2026 (depending on energy price trajectories)
• Spain, Portugal's largest trading partner, is forecast to grow around 2.2% in 2026

The Bank of Portugal projects 1.6% growth for 2027, down slightly from the 1.7% previously forecast. The institution warned that "in the medium term, the economy's evolution is constrained by demographic effects on labor supply and the reduction of net transfers from the EU."

This is a reference to two structural headwinds: Portugal's aging population (which shrinks the workforce) and the phasing down of EU COVID recovery funds and cohesion transfers after 2026.

What Supports Growth Despite Headwinds

The Bank of Portugal noted that several factors continue to support economic activity despite the downgrade:

• Solid labor market — unemployment remains near historic lows, and wages are rising
• Recovery and Resilience Plan (PRR) momentum — EU-funded infrastructure and modernization projects continue to inject demand into the economy
• Expansionary fiscal policy — the government is running a modest surplus but maintaining elevated public investment

These factors prevent a sharper slowdown but are insufficient to offset the external shocks from energy prices and conflict-related uncertainty.

What This Means for Expats

For expats living in Portugal, a 1.8% growth rate is neither boom nor bust — it's a modest expansion. The practical implications depend on your employment sector and household finances:

Job market: A growing economy, even slowly, generally supports job creation. However, sectors sensitive to energy costs (manufacturing, logistics, tourism with high transport exposure) may see slower hiring or wage growth. Tech, remote work, and professional services are less directly affected by energy prices and should remain resilient.

Inflation and cost of living: The 2.8% inflation forecast means prices will continue rising, especially for energy-dependent goods and services. Electricity, fuel, and food are the categories most likely to see above-average price increases. This erodes real incomes unless wages keep pace — something the Bank of Portugal expects will happen for most workers, but not uniformly across sectors.

Interest rates and mortgages: If the ECB raises rates to combat inflation (as the Bank of Portugal anticipates), Portuguese mortgage holders with variable-rate loans will face higher monthly payments. New borrowers will also encounter more expensive credit. For expats planning to buy property or take out loans, this is a headwind worth monitoring.

Exchange rates: Higher ECB interest rates typically strengthen the euro against other currencies. For expats earning income in euros, this is neutral. For those receiving income from outside the eurozone (UK pounds, US dollars, etc.), a stronger euro means reduced purchasing power in Portugal.

Portugal's Economic Resilience

Despite the downgrade, Portugal's economy has shown resilience over the past few years. The country emerged from the COVID-19 pandemic with strong tourism recovery, robust foreign investment (especially in tech and real estate), and improved public finances. The 2025 budget surplus of 0.7% — announced just one day after the Bank of Portugal's forecast — demonstrates fiscal discipline and provides some buffer against external shocks.

However, resilience has limits. Portugal's heavy reliance on imported energy makes it vulnerable to global supply disruptions. The country produces minimal oil and gas domestically, and while renewable energy capacity is growing (especially solar and wind), the transition is incomplete. Until Portugal (and Europe) achieves greater energy independence, Middle East conflicts will continue to pose economic risks.

Historical Precedent: Energy Shocks and Portugal

Portugal has weathered energy shocks before. The 1970s oil crises hit Portugal particularly hard, contributing to economic instability during the transition to democracy. More recently, the 2022 energy crisis following Russia's invasion of Ukraine caused inflation to spike above 9% in Portugal, though it later moderated.

The current situation is less severe than 2022 (so far), but the pattern is familiar: geopolitical conflict → energy price surge → inflation rise → growth slowdown. The Bank of Portugal's forecast reflects this well-established transmission mechanism.

What the Bank of Portugal Is Watching

The central bank's report emphasizes "high uncertainty" and notes that the baseline forecast could be wrong in either direction. Key variables the bank is monitoring include:

• Duration and intensity of Middle East conflict — prolonged war means sustained high energy prices
• ECB policy response — rate hikes could slow growth more than expected
• Weather patterns in 2026 — further extreme weather could compound early-year damage
• Consumer and business confidence — if uncertainty causes households to save more and businesses to delay investment, growth suffers

The bank stated that if the conflict intensifies, "there are heightened risks to the projection" — central bank language for "things could get worse."

Long-Term Challenges: Demographics and EU Funding

Beyond the immediate 2026 outlook, the Bank of Portugal flagged two structural issues that will shape the economy in coming years:

Demographics: Portugal's population is aging rapidly and shrinking in absolute terms. The working-age population is declining, which constrains economic growth unless offset by productivity gains or immigration. This is why Portugal's growing expat and immigrant population is economically significant — it helps counteract demographic decline.

EU funding phase-down: Portugal has benefited enormously from EU cohesion funds and, more recently, the €16.6 billion Recovery and Resilience Plan. As these programs wind down after 2026, Portugal will need to sustain investment and growth with less external support. This will require either higher domestic savings, more private investment, or fiscal consolidation.

Silver Lining: Inflation Expected to Moderate by 2027

The Bank of Portugal expects that "the dissipation of the shock to energy goods prices and the anchoring of long-term inflation expectations should contribute to consumer price stability by the end of the projection horizon, both in Portugal and the eurozone."

In plain language: if the war doesn't escalate and energy prices stabilize, inflation should fall back toward 2% by 2027-2028. This would allow the ECB to stop raising (or even cut) interest rates, supporting a return to stronger growth.

The Bottom Line

Portugal's economy is slowing but not stalling. A 1.8% growth rate is modest, not recessionary. For expats, the key takeaway is that 2026 will likely be a year of rising living costs (especially energy-related) and tighter credit conditions, but with employment and wages remaining broadly supportive.

The bigger question is whether Portugal can navigate the twin challenges of external energy dependence and internal demographic aging. The answer will shape not just 2026, but the decade ahead. (Background: see our piece on the first Portuguese bank-issued stablecoin.). (Background: see our piece on the IMF push to reverse the IRS Jovem and IVA reduzido on restaurants.)

Related: Cost of Living in Portugal 2026 | Portugal's Expat Population | Understanding Portuguese Income Tax On the Brussels macro-forecast tape, our preview of the European Commission Spring 2026 Forecast for Portugal — landing 21 May with revisions across GDP, deficit, inflation and debt sets the latest reference. On the sovereign-rating side of the spring macro file, our 22 May Moody's sovereign-rating read — the agency reaffirming Portugal at A3 with a stable outlook in the spring refresh, penciling 1.6% growth for 2026 and a 0.4% deficit return, citing the late-January storm cluster, the Middle East energy contagion, consecutive early elections and political fragmentation as the drag against the still-improving public-debt trajectory, while keeping Portugal one notch below the S&P / DBRS / Fitch placements sets the latest reference.