The European Central Bank will hike interest rates this week for the first time since September 2023, moving to tighten borrowing costs as the Iran war drives up energy prices across the eurozone.
Analysts expect the ECB's governing council to raise its key deposit rate by a quarter percentage point to 2.25 percent when it meets on Thursday. The move comes after inflation in the 19 eurozone countries accelerated to 3.2 percent in May, overshooting the ECB's two percent target. Energy costs have spiked globally following the US-Israeli conflict with Iran and the near-total closure of the Strait of Hormuz, a critical shipping route for oil.
The ECB held rates steady through 2024 as price growth cooled, but the new shock to energy markets has forced a rethink. Philip Lane, the bank's chief economist, signalled the hike in late May, telling Nikkei that he expects inflation forecasts to rise again at Thursday's meeting. "There are several factors related to the Iran war that show that the macroeconomic outlook has gotten worse," he said.
Higher borrowing costs work by dampening demand across the economy, which pushes inflation down. But they also make it costlier for households and businesses to borrow, a risk in a eurozone already struggling with weak growth. The European Union last month slashed its 2026 growth forecast for the single currency area to 0.9 percent from 1.2 percent. Revised data released Friday showed the eurozone economy contracted 0.2 percent in the first quarter.
Ludovic Subran, chief economist at Allianz, told AFP that the rate hike would mainly "provide reassurance" that the ECB was watching inflation. But he questioned whether it was necessary. "The ECB could wait, especially since the slowdown in growth is clear," he said. Other major central banks, including the US Federal Reserve and the Bank of England, have held rates steady as they assess the fallout from the conflict.
The ECB faces pressure not to repeat the mistake of 2022, when it moved too slowly to combat a historic surge in inflation triggered by Russia's invasion of Ukraine. After that crisis, the bank hiked rates aggressively, then cut them as prices fell. But most economists now see the situation as different. Inflation was already elevated before the Ukraine war, and the global economy was wrestling with post-pandemic supply chain problems. They don't expect Thursday's move to start an aggressive tightening cycle.
Jack Allen-Reynolds, deputy chief eurozone economist at Capital Economics, said he thought the ECB would likely deliver another hike at its July meeting but stop there. "The knock-on effects of higher energy prices on inflation should be limited, meaning that the ECB's tightening cycle will be short," he said.
Investors will watch ECB President Christine Lagarde's post-decision press conference for clues about the path ahead, though she is expected to offer little detail about future moves.
