Goldman Sachs says the risk of stagflation has returned to the discussion around European equities, as rising energy prices linked to the Middle East conflict combine with weaker economic growth forecasts across the region.
According to the bank’s strategists, the geopolitical tensions have shifted the macroeconomic backdrop away from the previously favourable “Goldilocks” environment. Goldman’s commodities team has increased its energy price projections, now expecting Brent crude to average $80 per barrel in the fourth quarter of 2026, compared with $60 before the conflict. European gas prices are also forecast higher, with TTF expected at €40 per megawatt-hour, up from the earlier €30 estimate.
At the same time, Goldman’s economists have downgraded their outlook for eurozone growth. GDP is now projected to expand 0.7% year-on-year in the fourth quarter, down from the 1.4% forecast before the conflict. Inflation expectations have also moved higher, with headline inflation now predicted to reach 3.2% by the second quarter, compared with the previous 2% estimate.
In response to these developments, central banks have adopted a more hawkish stance. The European Central Bank is now expected by markets to deliver three rate hikes this year, whereas prior to the conflict interest rate expectations had been broadly stable.
Goldman does not yet view stagflation as its base-case scenario, but warns that the risk profile has deteriorated. The bank noted that “the balance of risks has worsened and the probability of a stagflationary outcome has increased.” Strategists also highlighted that macroeconomic sensitivities tend to be non-linear, meaning downside risks could intensify if disruptions to shipping through the Strait of Hormuz persist.
Historically, stagflationary periods have been difficult for equity markets. Goldman’s analysis shows that the median real quarterly return for the STOXX 600 drops to around -1% during stagflation, compared with +3% in other economic environments.
“Stagflation exerts a double pressure on equities by (1) compressing fundamentals via margin pressure and (2) compressing valuations via higher rates and a more uncertain earnings outlook,” strategists led by Guillaume Jaisson said in a note.
Despite the growing risks, the bank believes equity markets have not fully priced in a stagflation scenario. While sector rotation has started to resemble a typical stagflation pattern — with Energy, Value stocks and Defensive sectors outperforming Growth and Cyclical names — the overall level of major indices suggests investors still expect the shock to remain manageable.
“Sharp policy repricing has created a regime within a regime,” the strategists wrote, adding that the current environment is producing sudden and sometimes non-linear sector shifts that make it difficult to identify consistent winners and losers.
From a positioning perspective, Goldman continues to favour a defensive approach. The bank is overweight Telecoms and Consumer Staples, while underweighting Consumer Discretionary, Autos and Chemicals.
It also sees opportunities in Defence and Fiscal Infrastructure, and continues to view European banks as an attractive value play for investors who believe stagflation risks will ultimately fade, citing resilient earnings profiles and strong income characteristics.
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