By Julia Payne
A new Middle East conflict and a U.S. assets sell-off are the two biggest risks to the euro zone, which, if twinned, could tip the euro area into a recession and send inflation near 5%, the European Stability Mechanism said in a report on Monday.
Europe is now far more exposed to American financial markets than a decade ago. The euro zone's GDP exposure to the United States stood at 47% last year, compared with 18% in 2013, the ESM said in its first annual report, titled Euro Area Stability Watch.
"Rising political uncertainty, longer-run fiscal sustainability concerns, and stretched equity valuations built on artificial intelligence-related earnings expectations create the potential for a sudden asset price correction emanating from the U.S.," the report said.
The ESM, a European crisis fund worth over €430 billion ($491 billion), outlined this vulnerability alongside the possibility of a new Middle East energy shock.
The Iran war had a major impact on global energy markets and supply chains due to the four-month closure of the vital shipping lane - the Strait of Hormuz. American and Iranian negotiators have yet to agree a lasting peace since their interim deal last month.
If both risks hit, the euro area's GDP may only rise 0.6% in 2026 and contract by 0.4% in 2027.
"The euro area has large and increasing holdings of U.S. portfolio investments. At end-2025, the U.S. accounted for nearly half of the euro areaʼs total global portfolio holdings - 59% of equity positions and 36% of debt, compared with roughly one-third in 2013," the report said.
"Therefore, a material repricing of U.S. assets would bring substantial direct losses for European investors."
($1 = 0.8758 euros)