Bank of Portugal Slashes 2026 Growth Forecast to 1.8% as Middle East Conflict Drives Energy Shock and Consumer Confidence Crashes

Portugal's economic outlook has deteriorated sharply in the wake of the US-Israel attack on Iran in late February, forcing the Bank of Portugal to cut its 2026 growth forecast by a full half percentage point to 1.8%, down from the 2.3% projected just three months ago. The revision, published in the central bank's March Economic Bulletin, reflects the cascading effects of soaring energy prices and weakening household sentiment as the Middle East conflict reshapes the country's economic trajectory.

The attack sent oil prices surging to over $100 per barrel by mid-March — a 49% jump from December's $63 — while European natural gas prices nearly doubled from €28 to €51 per megawatt-hour over the same period. For Portugal, heavily reliant on imported energy, the shock is immediate and severe.

"This projection reflects the deterioration of the external environment following the attack launched by the US and Israel on Iran at the end of February," the Bank of Portugal stated in its bulletin, adding that the "abrupt and significant rise in energy commodity prices has a negative impact on activity and a positive impact on inflation, especially in 2026."

Inflation Surges as Consumers Pull Back

Inflation is now expected to hit 2.8% in 2026, up from the 2.1% forecast in December, as energy costs ripple through the economy. The spike is already eroding household purchasing power and dampening consumer sentiment. Portugal's consumer confidence indicator fell in March to its lowest level since December 2023, according to data from INE (Portugal's National Statistics Institute), as households confront rising fuel, heating, and food costs.

The economic climate indicator also retreated to a one-year low, underscoring the broader malaise. The Bank of Portugal projects zero GDP growth in the first quarter of 2026, followed by a modest 0.4% expansion in subsequent quarters as the initial shock dissipates. Yet even this recovery assumes energy prices stabilise — a precarious assumption given the volatile geopolitical landscape.

Domestic Shocks Compound External Pressures

Portugal's growth troubles aren't purely external. The country was battered by extreme weather in early 2026, with Storm Kristin and weeks of torrential rain between late January and mid-February causing widespread damage to homes, farms, and infrastructure, particularly in the Central region. The government declared a state of calamity in 68 municipalities representing 17% of the national population.

The combined effect of climate disaster and energy shock has left Portugal navigating a precarious first quarter. The Bank of Portugal's zero-growth projection for Q1 marks a stark reversal from the relatively strong momentum seen in late 2025.

Labour Market Holds, But Headwinds Loom

Despite the grim headlines, Portugal's labour market remains resilient. The unemployment rate is forecast to stabilise at 5.9% in 2026 and hover around 5.8% in subsequent years — historically low levels. Public investment, propelled by the Portugal Recovery and Resilience Plan (PRR), is also expected to support the economy, with gross fixed capital formation projected to grow 3.8% this year, slightly above 2025's 3.5%.

However, the medium-term outlook is clouded by demographic and fiscal realities. As PRR funds taper off and net EU transfers decline, Portugal's growth engine will increasingly depend on productivity gains and labour supply — both constrained by an ageing population and slowing immigration. The Bank of Portugal anticipates growth of 1.6% in 2027 and 1.8% in 2028, still above the eurozone average but with narrowing differentials.

Risks Tilted Downward

The central bank is clear-eyed about the uncertainties ahead. "The risks to the projection have intensified since December, in a context of high global uncertainty," the bulletin warns. "The balance of risks is skewed downward for activity and upward for inflation."

A prolonged or escalating Middle East conflict could trigger further energy price spikes, disrupt global supply chains, and rattle financial markets. Meanwhile, US tariffs — including a new 10% levy on all trading partners — pose a direct threat to Portugal's export-driven manufacturing sector.

For Portugal's immigrant and expat communities, the inflation surge is particularly acute. Many arrived during the pandemic boom years expecting a lower cost of living than Northern Europe, only to find themselves squeezed by rapid rent increases, stagnant wages in some sectors, and now a renewed surge in everyday costs. The energy shock disproportionately affects lower-income households, who spend a larger share of their budgets on heating, transport, and food.

Policy Response Under Scrutiny

The Bank of Portugal has urged policymakers to stay the course on fiscal consolidation and structural reform. "In this context of geopolitical tension and demographic constraints, it is essential that Portugal maintains the trajectory of reducing public and private debt, continues to strengthen the population's qualifications, and creates conditions to increase investment and the adoption of new technologies," the central bank said.

The government has already responded with fuel tax relief and subsidies, but the Finance Ministry has also warned that a small budget deficit may be unavoidable in 2026, breaking the surplus trajectory achieved in 2025. Whether Portugal can balance economic stimulus with fiscal discipline — while absorbing twin shocks from nature and geopolitics — will define the rest of the year.

For now, Portuguese households are bracing for a long, expensive spring.