The European Central Bank raised interest rates by a quarter percentage point Thursday, taking its benchmark deposit rate to 2.5% as surging energy costs from the war involving the U.S., Israel and Iran pushed eurozone inflation above 3% and forced policymakers to confront renewed price pressures alongside weak economic growth.
The widely expected increase was the ECB's second rate rise since the Middle East conflict began and followed a pause in July. The deposit rate moves to 2.5% from 2.25%, extending a reversal in monetary policy that began after the energy shock disrupted the eurozone's earlier progress toward the central bank's 2% inflation target.
The ECB said the move "underscores the Governing Council's commitment to setting monetary policy to ensure that inflation stabilises at its 2% target in the medium term," according to its policy statement.
What comes next is less straightforward. The central bank warned that the outlook remains "highly uncertain, with risks to the upside for inflation and to the downside for economic growth," leaving policymakers to judge how long the energy shock will last and how extensively higher fuel costs will spread into wages, goods and services.
The ECB's updated baseline projections put headline inflation at an average 3.0% in 2026, followed by 2.5% in 2027 and 2.1% in 2028, according to the source article. Inflation excluding energy and food is projected at 2.5% this year, 2.6% next year and 2.3% in 2028.
Those forecasts point to a more persistent inflation problem than the ECB envisioned earlier in the year. Its June projections had put headline inflation at 3.0% in 2026, 2.3% in 2027 and 2.0% in 2028, while core inflation was forecast at 2.5% in both 2026 and 2027 and 2.2% in 2028.
"The baseline foresees 2.5% in 2026, 2.6% in 2027 and 2.3% in 2028. Compared with June, the baseline projection for inflation in 2026 is unchanged, while it has been revised up for 2027 and 2028," the ECB said of inflation excluding energy and food, according to the source article.
The immediate inflation data help explain Thursday's decision. Eurostat estimated that eurozone consumer prices rose 3.3% in August from a year earlier, accelerating sharply from 2.9% in July and moving further above the ECB's target.
Energy was overwhelmingly the strongest inflation component. Energy prices increased 14.3% from a year earlier in August, compared with 10.3% in July, while services inflation actually eased to 3.0% from 3.3%. Inflation for non-energy industrial goods increased to 1.2%, and food, alcohol and tobacco remained at 1.2%.
That divergence complicates the ECB's task. Higher interest rates can restrain demand, credit growth and domestically generated price pressures, but they can't produce additional oil or liquefied natural gas when geopolitical disruptions constrain supply.
Europe is particularly exposed because of its reliance on imported energy. Natural-gas prices have climbed to their highest levels since January 2023 as the Iran conflict restricts Qatari LNG exports through the Strait of Hormuz, while European storage inventories are unusually low heading toward the winter heating season.
Oil has added to the pressure. Brent crude settled above $100 a barrel Wednesday after the U.S. and Iran struck tankers in the biggest wave of attacks on Gulf shipping since the conflict began, threatening further disruption through a waterway that previously handled roughly one-fifth of global oil supplies.
The energy shock has also pushed the ECB toward a more cautious approach to forward guidance. In July, the Governing Council left rates unchanged at 2.25% and said it wouldn't "pre-commit" to a particular interest-rate path, instead emphasizing a meeting-by-meeting assessment of inflation, incoming economic data and monetary-policy transmission.
Thursday's increase was nevertheless broadly priced into financial markets. Reuters reported that investors expect additional tightening but that policymakers are likely to proceed cautiously because underlying inflation has moderated and wage growth is slowing even as energy pushes headline inflation higher.
The ECB's economic outlook provides another reason for caution. Its new baseline raises the 2026 growth forecast slightly to 0.9% from the 0.8% projected in June, Reuters reported, leaving the eurozone expanding only modestly while households and businesses absorb higher energy and borrowing costs.
"In relation to the energy shock, the updated scenarios put together by staff illustrate the broad range of outcomes for how growth and inflation would evolve under different assumptions about its intensity and duration, as well as its indirect and second-round effects," the ECB said, according to the source article.
The Governing Council said the latest increase leaves it "well positioned to navigate the uncertainty caused by the conflict," while preserving the option to change course as new data arrive. It also reiterated that it "stands ready to adjust all of its instruments within its mandate to ensure that inflation stabilises at its 2% target in the medium term and to preserve the smooth functioning of monetary policy transmission."
