Just as energy markets appeared to be stabilising, the war in the Middle East has again shown how quickly geopolitical shocks can complicate the inflation and monetary policy outlook. Although the fragile ceasefire between the United States and Iran has eased immediate energy-market pressures, it has not eliminated uncertainty surrounding inflation, interest rates, and monetary policy, especially in the wake of renewed hostilities.

This tension between cyclical price shocks and more structural sources of inflation provides a useful entry point for this issue of Spanish and International Economic & Financial Outlook (SEFO). Nowhere is that distinction more visible than in housing. Energy shocks can fade, commodity prices can correct, and central banks can recalibrate policy. But housing affordability pressures reflect deeper structural constraints: insufficient supply, planning rigidities, demographic pressures, financial-market exposure, and political incentives that often make well-intentioned policies less effective than expected.

Against this backdrop, the July issue of SEFO explores the housing affordability challenge in Spain and Europe, examining why it has become one of the defining structural economic issues facing policymakers and financial markets alike.

We begin with an assessment of Spain’s inflation outlook after the Persian Gulf ceasefire. [1] The memorandum of understanding between the United States and Iran has eased the acute phase of the inflationary shock triggered by the conflict, with oil and gas prices moving towards pre-conflict levels as the Strait of Hormuz reopens to shipping. Even so, normalization will be gradual, as demining operations in the Strait and rebuilding damaged infrastructure could keep commodity prices above their pre-war levels through year-end. Production costs across Spanish industry continue to reflect the shock, feeding through to consumer prices with a lag and offsetting part of the disinflationary effect of lower energy costs. At the same time, the scheduled withdrawal of Spain’s fuel tax relief will add substantially to headline inflation. Beyond these energy-related developments, core inflation has proven more persistent than forecast, reflecting structural pressures that predate the conflict, particularly in services sectors. Altogether, inflation is projected to average 3.3% in 2026, well above the euro area as a whole, leaving monetary policy poorly positioned to address a shock that is becoming increasingly domestic in origin.

The issue then turns to the European Central Bank’s response to the latest geopolitical shock, examining how the latest policy decisions reflect the difficult balance between responding to temporary geopolitical shocks and ensuring that more persistent inflation pressures do not become embedded. The ECB’s 25 basis point rate rise on 11 June 2026 sets it apart from the Federal Reserve and the Bank of England, both of which held rates steady the following week despite acknowledging elevated inflation and resilient growth. The divergence reflects the central role of judgement in monetary policymaking under conditions of deep uncertainty, when a ceasefire can be announced the day after a Governing Council meeting and collapse shortly thereafter. The war in the Middle East has produced a classic stagflationary tension: energy and commodity shortages pushing up prices while uncertainty suppresses investment and consumption, with second-order effects on trading partners amplifying both dynamics. The Governing Council’s primary concern is not the current data but the risk that firms and households stop looking through temporary price rises and begin embedding higher inflation into wages, contracts, and business models, a de-anchoring that survey data would only confirm with a significant lag. The ECB’s experience during the 2020-2024 inflation-disinflation cycle, when delayed action allowed inflation to exceed 10% before the tightening response, has raised the institutional premium on demonstrating a capacity to act early. Structural factors, including climate adaptation costs, AI investment, and demographic pressures pulling in opposite directions, mean the neutral rate remains contested and offers little practical guide, giving the Governing Council room to treat a 25 basis point move as predominantly symbolic. The broader implication is that other central banks may face similar pressure to show their own capacity to act, regardless of what the data say at the moment of decision.

From there, the July SEFO shifts to its central theme: Europe’s housing affordability crisis. First, we examine why decades of well-intentioned housing policies have often failed to improve affordability, arguing that increasingly inelastic housing supply and restrictive planning systems lie at the heart of Europe’s structural housing shortage. Europe’s housing affordability crisis reflects a fundamental mismatch between growing demand and increasingly inelastic supply, particularly in economically dynamic cities where planning constraints have become progressively more binding. Despite continued population growth, housing completions per capita have fallen substantially across the continent. As outward urban expansion has been curtailed, housing expansion has become increasingly dependent on redevelopment, a process that is slower, costlier, and more politically contentious than greenfield construction, and which often replaces affordable older stock without meaningfully expanding the total housing stock. Demand-side interventions such as mortgage subsidies and first-time buyer schemes tend to be capitalised into higher land values where supply is constrained, benefiting existing owners and developers rather than prospective buyers. The political economy of homeownership further reinforces these dynamics. Homeowners, whose wealth is tied to property values, have incentives to lobby for more restrictive land use regulation. The resulting reduction in housing supply responsiveness amplifies house price and rent growth, benefiting incumbent — particularly older — homeowners while imposing welfare losses on renters, younger households, and future generations. Lasting improvement in affordability requires evaluating policies by their long-run general equilibrium effects and reforming planning and tax systems to align political incentives with the objective of expanding housing supply.

The discussion then moves to Spain, analysing the country’s affordable housing challenge and the opportunities created by the EU’s revised framework for services of general economic interest to mobilise both public and private investment in expanding affordable housing supply. Spain’s housing crisis reflects a structural supply-demand imbalance that has deepened over the past decade, pushing not only vulnerable households but middle- income groups out of urban rental and purchase markets. Net investment in social housing has been virtually stagnant since 2013, with much of the earlier public effort eroded as subsidised homes were deregulated back into the open market. Private developers have retreated from the affordable segment because regulated rents and price caps routinely fail to cover construction and land costs, producing a funding gap that, absent public compensation, makes investment unviable regardless of demand. The decisive regulatory shift comes from the revised EU SGEI Decision of late 2025, which formally designates affordable housing as a service of general economic interest, allowing public authorities to compensate developers without prior Commission notification, provided compensation does not exceed net costs plus a reasonable return. Activating this framework requires Spanish authorities to define public service obligations, model funding gaps precisely, and establish transparent compensation parameters, disciplines that would sharpen housing policy while giving patient private capital the legal certainty it has lacked. The framework’s main virtue is that it integrates available instruments, allowing land transfers, subsidies, and construction grants from different levels of government to be bundled within a single project without triggering state aid accumulation rules.

Housing is then examined through a financial stability lens. Rather than the credit-fuelled excesses that characterised the period before the global financial crisis, European real estate risks today increasingly reflect structural supply shortages, affordability pressures, commercial real estate vulnerabilities, climate risks, and regulatory distortions. European real estate markets no longer pose the risks that defined the pre- 2008 period, yet policy and public debate have been slow to update their analytical frameworks. The central challenge has shifted from credit-fuelled oversupply to an ecosystem of interconnected vulnerabilities, namely supply shortfalls, affordability deterioration, commercial real estate stress, and climate exposure. Spain exemplifies the new profile: despite household debt falling from over 85% of GDP in 2010 to around 44% today, affordability has deteriorated sharply, annual housing completions fall well short of household formation rates, and the rate of young people living independently remains among the lowest in Europe, with housing access increasingly dependent on family wealth transfers. At the EU level, financial concern has migrated toward commercial real estate, where remote work consolidation, rising refinancing costs, and falling property valuations have created concentrated exposures in several northern European banking systems. Demand- side subsidies and rent controls, however well-intentioned, tend to inflate prices in unregulated segments when supply is structurally inelastic, substituting short- term relief for the structural reforms that shortages require. The broader implication is that housing can no longer be treated as an ordinary market: dysfunction can ripple through productivity, labor mobility, and intergenerational equity in ways that now make it essential economic infrastructure.

Next, we consider what these developments mean for Spain’s banking sector. Although banks remain closely linked to the housing market, their balance sheets are considerably more resilient than before 2008, reflecting profound changes in lending patterns and risk exposure. Since the 2008 financial crisis, Spanish banks have radically rebalanced their real estate loan books, shedding the developer and construction credit that once defined their property exposure in favour of lower-risk home mortgages. Before the crisis, high-risk loans to those two segments dominated the portfolio; by 2025 their combined share of real estate credit had fallen from 42% to just 16%, while lower- risk home mortgages now account for the large majority of the banks’ property-related lending. The correction was accompanied by severe asset quality deterioration: non-performing loan ratios reached 30% in property development and 34.3% in construction at their 2013 peak, before recovering sharply as restructuring efforts and improved economic conditions took hold. Today, overall non-performance in real estate has receded to levels broadly in line with pre- crisis norms. A comparison with European peers, using European Banking Authority consolidated data, confirms that Spanish banks remain somewhat more exposed to real estate than the EU average, though this gap is attributable to Spain’s entrenched home ownership culture rather than speculative lending. In the higher-risk construction and developer segments, Spanish banks carry below-average non-performance ratios relative to European peers. On balance, the sector is navigating the current real estate cycle, characterised by rising prices driven by a supply-demand imbalance, from a position of substantially greater solvency and resilience than in the recent past.

Attention then turns to bank profitability, exploring how Spanish banks are adapting to a period in which higher interest margins are expected to normalise and long-term profitability will increasingly depend on business diversification and customer relationships. As rate tailwinds fade, Spanish banks face the structural challenge of sustaining profitability without relying on net interest margin expansion. Loan portfolio composition proves central to this challenge. Banks with higher loan-to-asset ratios consistently generate stronger interest income, while holdings in fixed-income securities and interbank assets correlate negatively with yields. Within the loan book itself, segment diversification is a decisive differentiator: entities with greater exposure to business and consumer lending report higher loan yields than those concentrated in mortgages, reflecting the higher risk, shorter duration, and repricing flexibility of those segments. Given the structural weight of mortgage lending in Spanish bank portfolios, customer bundling emerges as a complementary lever. Banks with higher mortgage volumes show a strong positive correlation with off-balance sheet assets, and the resulting fee income offsets compressed interest margins on standardised products. Sustaining profitability ultimately requires balancing portfolio diversification with a shift toward customer-level profitability management, supported by analytical frameworks that link product mix to lifecycle value.

The issue subsequently broadens to household and corporate balance sheets, assessing how Spanish households and firms have navigated the recent period of inflation and higher interest rates, and what this implies for investment, savings, and financial resilience. Spain’s household and non-financial corporation accounts for 2025 reflect the defining traits of the current growth phase: robust nominal income growth, cautious balance sheet management, and persistent weakness in business investment. Household disposable income grew in nominal terms, driven mainly by employment expansion, but real per-capita gains were modest and purchasing power remains only marginally above 2019 levels. The savings rate declined as consumption growth outpaced income with net household lending falling to 2.9% of GDP. However, debt leverage and debt service burdens continued to ease and financial wealth rose sharply on the back of equity and investment fund revaluations. For non- financial corporations, operating surpluses grew in nominal terms but the profit share in gross value added continued to compress, and real earnings have still not recovered to pre- pandemic levels. Both sectors nonetheless again generated net lending positions and saw significant asset revaluations, leaving them with meaningful buffers against an uncertain macroeconomic outlook.

Finally, we conclude this SEFO with an examination of one of the structural forces that will increasingly shape Spain’s public finances over the coming decades: population ageing. Beyond its well-known effects on public spending, demographic change is also expected to erode the tax base, reinforcing the importance of policies that support both housing supply and long-term economic growth. Population ageing poses well- documented risks to public finances through higher spending, but its revenue implications have received comparatively little attention in the Spanish literature. This analysis focuses on the three taxes that together account for around 77% of total tax revenue—personal income tax, social security contributions, and VAT—and estimates their exposure to demographic change through a static simulation that applies projected 2040 household age distributions to 2025 tax data. Personal income tax is the most structurally vulnerable, given its reliance on earned income, which peaks during prime working years before declining after retirement as wages are replaced by pensions. Social security contributions face analogous pressure as the pensioner share grows and the wage share of national income contracts. VAT revenue is affected both because older households spend less overall and because they devote a larger share of consumption to goods subject to reduced rates, such as food, medicines, and assistive devices. Aggregating across all three taxes, the simulation points to a total revenue reduction of around 3.3%, equivalent to approximately 12.9 billion euros, with the burden of revenue generation shifting toward households whose main earner is aged between 60 and 75. Offsetting this shortfall through immigration would require around 650,000 additional households in the 30–39 age bracket, although this estimate is conservative, as immigrant households tend to generate less tax revenue than native households of comparable age.

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