Bank of Portugal Slashes Growth Forecast as Middle East War Hits Economy

Portugal's economy faces a sharper slowdown than anticipated as the Bank of Portugal cut its 2026 GDP growth forecast to 1.8%, down from December's 2.3% projection—a revision driven by the escalating conflict in the Middle East and severe winter storms that battered the country.

The 0.5 percentage point downgrade, published Wednesday in the central bank's March Economic Bulletin, reflects the rapid deterioration of the external environment following the late February attacks by the US and Israel on Iran. The conflict triggered immediate and severe shocks to global energy markets that Portugal cannot escape.

Energy Prices Surge Nearly 50%

The numbers tell a stark story. Oil prices surged to over $100 per barrel by March 13—the bulletin's closing date—compared to $63 in December 2025, representing a 49% increase in euro terms. Natural gas experienced an even more pronounced spike, jumping from €28 per megawatt-hour in December to €51 by mid-March.

"This projection reflects the deterioration of the external framework following the attack launched by the US and Israel on Iran at the end of February," the Bank of Portugal explained in its report. The energy price shock has immediate negative effects on economic activity while simultaneously pushing inflation higher.

The central bank now projects inflation will reach 2.8% in 2026, up sharply from the 2.1% estimated in December. For expats and immigrants whose incomes may not keep pace with Portuguese wage adjustments, this represents a real erosion of purchasing power—particularly as food prices have already hit record highs.

Weather Catastrophe Compounds Economic Woes

As if geopolitical turmoil weren't enough, Portugal's economy also absorbed a domestic blow. Between late January and mid-February, Storm Kristin and persistent heavy rainfall caused extensive damage across the country, with the hardest-hit Centro region accounting for 17% of Portugal's population.

The government declared a state of calamity in 68 municipalities. Damage extended to residential and commercial buildings, agricultural land, and critical infrastructure including electricity distribution networks, transportation systems, and communications infrastructure.

The Bank of Portugal projects zero GDP growth in the first quarter of 2026, with recovery to 0.4% quarterly growth in subsequent quarters. The combination of external energy shocks and internal climate disasters created a perfect storm for economic activity at the start of the year.

What's Keeping the Economy Afloat

Despite this challenging backdrop, several factors continue to support Portugal's economic resilience. The labor market remains robust, with unemployment projected at 5.9% in 2026 and stabilizing around 5.8% in subsequent years—historically low levels that reflect continued immigrant employment growth.

Public investment should also provide a boost. The Recovery and Resilience Plan (PRR) continues to drive capital formation, with gross fixed capital formation expected to grow 3.8% this year, above 2025's 3.5%. The central bank noted that fiscal policy maintains an expansionary orientation, providing additional support.

For the medium term, the Bank of Portugal maintains recovery expectations: 1.6% growth in 2027 and 1.8% in 2028, slightly above previous estimates. Portugal will continue growing faster than the eurozone average—which the European Central Bank revised down to just 0.9% for 2026—though the differential narrows over the projection horizon.

Risks Tilted Toward Worse Outcomes

The central bank pulls no punches about uncertainty. "Adverse 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 intensified Middle East conflict could trigger further commodity price spikes, increase financial market volatility, and disrupt global supply chains. Meanwhile, international trade tensions pose relevant risks to Portuguese exports, particularly for manufacturing industries.

The US recently introduced a common 10% tariff on all trading partners, adding another layer of uncertainty for export-dependent Portugal.

The Policy Imperative

Facing these headwinds, the Bank of Portugal emphasized what Portugal must do. "In this context of geopolitical tension and demographic constraints, it is essential that Portugal maintain its trajectory of reducing public and private debt, continue strengthening the population's qualifications, and create conditions to increase investment and the adoption of new technologies."

For Portugal's large expat and immigrant community, this economic recalibration means navigating higher living costs while the government attempts to balance fiscal responsibility with growth support. The inflation spike will hit hardest on those without indexed incomes or savings buffers.

The good news: the energy shock should prove temporary, with inflation moderating to 2.3% in 2027 and 2% in 2028 as effects dissipate and long-term inflation expectations remain anchored. The bad news: April's grocery bills are about to get worse before they get better.