ECB Expected to Hike Again as Inflation Stays Elevated

The European Central Bank raised its key interest rates by 25 bps at its September meeting, marking its second hike since the US-Iran war began. The ECB said the conflict in the Middle East continues to fuel inflationary pressures, with inflation expected to remain well above its 2% target for an extended period. The main refinancing rate was raised to 2.65%, while the deposit rate increased to 2.5%. Meanwhile, the ECB kept its 2026 inflation forecast at 3.0% but revised its projections higher for 2027 and 2028, to 2.5% and 2.1%, respectively. Growth forecasts were upgraded to 0.9% for 2026 and 1.4% for 2027, reflecting greater-than-expected resilience in the euro area economy, while the 2028 forecast remained unchanged at 1.5%. At a press conference following the meeting, ECB President Christine Lagarde said risks to growth are tilted to the downside, while inflation risks are currently tilted to the upside, reiterating that future decisions will be made on a meeting-by-meeting basis.

The European Central Bank is expected to raise its key interest rates by 25 basis points on Thursday, marking the second hike since the US-Iran war began, while signaling caution over further increases that could weigh on economic activity. The main refinancing rate is expected to rise to 2.65%, and the deposit rate to 2.5%. Eurozone inflation accelerated to 3.3% in August, its highest level in three years and well above the ECB’s 2% target. However, there have been few signs of the second-round inflation effects policymakers typically fear when energy prices surge, as they have since the war closed the Strait of Hormuz. Economists remain unconvinced that further tightening will be necessary, warning that additional hikes could risk recession. Interest-rate futures, however, are pricing in a third hike by December, while policymakers continue to flag upside risks to inflation and the recent rise in bond yields adds further uncertainty to the policy outlook.

All ECB policymakers agreed to leave rates unchanged at the July meeting, following the first rate hike since 2023 in June, citing elevated uncertainty and the fact that the full inflationary impact of the energy shock had yet to emerge, according to the latest minutes. However, some said they would not have opposed another hike, noting that the likelihood of further tightening becoming unnecessary remained low. Policymakers saw upside risks to inflation and downside risks to growth from geopolitical developments in the Middle East and the Russia-Ukraine war, while stressing that communication should remain clear to avoiding any pre-commitment to a September move. The minutes emphasized that the July pause should not be interpreted as the end of the tightening cycle, with another hike likely unless the inflation outlook improves significantly. At the same time, policymakers wanted to keep the September decision open, allowing room for the medium-term inflation outlook to improve.