The European Central Bank (ECB) raised its key deposit rate by a quarter of a percentage point to 2.25 per cent on Thursday, marking the first increase in almost three years, amid signs that the Iran war is having a broader impact on inflation than the spike this year in energy prices.
The bank also increased its main lending rate, to which ECB tracker mortgage costs are linked, to 2.4 per cent.
While ECB president Christine Lagarde insisted repeatedly during a press conference that the bank’s governing council is not on a predetermined rates path, most economists expect another increase in September.
A homeowner with a tracker rate on a €150,000 loan with more than 10 years left faces an annual increase of just over €200 in their repayments as a result of Thursday’s decision, according to Daragh Cassidy, spokesman for comparison website Bonkers.ie. The ECB change will also influence how lenders generally price credit and deposits.
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“The war in the Middle East remains a major source of uncertainty. The longer energy prices stay high, the more likely they are to drive up broader inflation,” Lagarde said.
The ECB is the world’s first major central bank to increase rates as a result of the conflict. It had been among the slowest to move after a surge in inflation in the wake of the Covid-19 pandemic and Russia’s invasion of Ukraine.
Euro-zone inflation rose to an annual rate of 3.2 per cent in May, well above the ECB’s 2 per cent target, as energy prices soared 10.9 per cent, according to Eurostat, the European Union’s statistics agency. Within that, core inflation – which excludes energy and food – rose by 2.5 per cent, indicating that the energy shock is having a broader influence on consumer prices across the single-currency region.
The ECB moved its key deposit rate from minus 0.5 per cent to 4 per cent between June 2022 and September 2023, as euro-zone inflation soared to as high as 10.6 per cent, driven by the effects of the pandemic and the Ukraine war. It subsequently lowered the rate to 2 per cent through a series of cuts over 13 months to September last year.
“The question is, how far can this tightening cycle go? Not far, is our answer,” said Mark Wall, an economist with Deutsche Bank. “There is upside risk to inflation, but there is also downside risk to growth. One more hike in September and that’s it.”
The governing council decision follows a move by ECB staff to increase their inflation forecasts and lower their economic growth projections.
They now expect headline inflation to average 3 per cent this year, before easing to reach the ECB’s 2 per cent target in 2028. For inflation excluding energy and food, the rate is expected to average 2.5 per cent this year and edge lower to 2.2 per cent in 2028.
ECB staff now see euro zone economic growth averaging 0.8 per cent this year, 1.2 per cent in 2027 and 1.5 per cent in 2028. “This is a downward revision for 2026 and 2027, reflecting a more pronounced impact of the war on commodity markets, real incomes and confidence,” the ECB said.
“Today’s move is very much as expected, and marks a clear signalling by the ECB of its intent to stay ahead of inflation risks while maintaining a measured policy stance,” said Stephen Grissing, investment strategist at Davy. “It had previously been criticised for reacting too slowly in 2022, increasing rates after inflation had already climbed above 8 per cent year-on-year, in comparison to the 3.2 per cent level it sits at today.”
A number of ECB watchers said in advance that a rate increase would amount to an “insurance hike” – or precautionary move. However, Lagarde insisted the decision had to be taken, given how inflation is forecast to remain above the ECB’s target and has started to spread beyond energy prices.
