The European Central Bank has raised interest rates for the second time in 2026 in a widely flagged move, hoping to tame an inflation rise driven entirely by higher energy costs from the Iran war.
Surging oil and natural gas prices pushed inflation well past 3 per cent across the 21-country euro zone in August, far exceeding the ECB’s 2 per cent target, and a recent escalation of the conflict points to further price pressures that could eventually seep into wage-setting.
“The outlook remains highly uncertain, with risks to the upside for inflation and to the downside for economic growth,” the ECB said in a statement after meeting in Berlin on Thursday, continuing its long tradition of holding one policy meeting a year in a different euro zone city.
The ECB also lifted its 2026 economic growth projection to 0.9 per cent from 0.8 per cent seen in June and now sees inflation averaging 3.0 per cent this year and 2.5 per cent in 2027.
Thursday’s hike raises the ECB’s benchmark deposit rate to 2.5 per cent, the upper end of the “neutral” range considered by policymakers to neither restrict nor stimulate economic growth.
While financial investors are betting on further hikes later this year and in 2027, the ECB is likely to take its time with any follow-up move given a mixed outlook.
High energy costs suggest persistent inflation, and all hopes are gone for a quick end to the US-Israeli war on Iran, which began in late February. High natural gas prices are a growing worry, too, with gas storage levels below historic norms as the winter heating season approaches.
Economic growth is meanwhile holding up much better than feared, indicating a resilience that could also put upward pressure on prices.
High energy costs have yet to filter down into the price of other goods and services, however, confounding fears that second round effects would be quickly visible.
Underlying inflation, which filters out volatile food and fuel prices, even slowed in August on moderating services inflation, while growth in wages, a crucial indicator to gauge price pressures, keeps slowing.
Bond yields have also increased sharply, mostly reflecting similar rises for US Treasuries, tightening financing conditions and doing some of the central bank’s work for it.
These factors suggest that even if price pressures persist, they are far less than in 2022, when inflation shot past 10 per cent as energy prices spiked following Russia’s invasion of Ukraine.
Attention now turns to ECB President Christine Lagarde’s press conference later on Thursday.
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