Euro zone faces big growth hit even if Iran war quickly resolved, IMF says

WASHINGTON, April 14 (Reuters) - Euro zone growth will slow this year and inflation surge, forcing the European Central Bank to lift interest rates, even if the economic disruptions caused by the Iran war fade by mid-year, the International Monetary Fund said on Tuesday.

Importing most of its energy needs, the euro zone economy is especially vulnerable to spiking energy costs, especially since Russia's war in Ukraine has already strained the bloc's access to crucial resources.

Growth is now seen slowing to 1.1% this year from 1.4% in 2025, below the 1.3% predicted in January, as the war more than negates better-than-predicted expansion at the end of last year, the IMF said in its World Economic Outlook.

"The (war's impact) will add to the lingering effects of the persistent rise in energy prices since Russia's invasion of Ukraine, dragging on manufacturing, with additional pressure from the real appreciation of the euro relative to currencies of countries exporting similar products," the IMF said.

Still, the IMF is more optimistic than the ECB, which predicted 0.9% growth under its own baseline last month before a quick pick up in 2027.

A planned rise in defence spending will mitigate some of the expected drag but the ramp up in spending is relatively slow, so the boost is likely to materialise later, the IMF added.

Inflation will meanwhile jump to 2.6% in 2026 from 2.1% last year, according to the IMF's 'baseline' projection, which assumes that the war will have limited duration, intensity, and scope, allowing disruptions to fade by mid-2026.

The ECB's 2% deposit rate is then likely to rise by 50 basis points over the course of 2026 in response to this inflation increase, the IMF said.

This predicted increase is in line with market bets and investors have fully priced in a rate hike by June on the premise that the ECB will want to send an early signal that it will not tolerate inflation spreading beyond energy and generating a self-sustaining price spiral.

However, much like the ECB, the IMF said that far worse outcomes are possible and its 'adverse' and 'severe' scenarios pointed to larger growth hits across the world and a bigger rise in inflation. (Reporting by Balazs Koranyi; Editing by Alistair Bell)