ECB raises rates for first time since 2023 as Iran war drives inflation higher

On Thursday, the European Central Bank increased its deposit rate by 25 basis points to 2.25% in its first rate hike since September 2023. The escalation of the war in the Middle East sent inflation within the eurozone significantly above the bank’s target of 2%.

The ECB has become the first major central bank to tighten monetary policy because of the energy shock arising from the US-Israeli war against Iran.

The conflict, which began in late February, has effectively shut down the Strait of Hormuz, a chokepoint that previously handled roughly 20% of global oil and gas shipments, as Cryptopolitan reported in March when eurozone inflation was tracking at 2.5%.

ECB warns inflation pressure is spreading

In May, inflation in the 21 countries of the eurozone rose 3.2 percent on an annual basis while the price of energy recorded an increase of 10.9 percent.

Excluding energy and food prices, it amounted to 2.5 percent in May up from 2.2 percent in April indicating the current price pressures go beyond just energy prices.

The Governing Council said the war is “generating inflation pressures” and called the move “robust across a range of scenarios” for how the shock could evolve.

ECB staff now expect headline inflation to average 3.0% in 2026, an increase from their March forecast of 2.6% and subsequently fall to 2.3% in 2027 and hit the target rate of 2% in 2028.

Christine Lagarde, speaking to the media in Frankfurt has offered no indication of future action.

“We are not pre-committing to a particular path of rates”, she stated, whilst noting upside risks to inflation and downside risks to growth.

The central bank cut growth forecasts and pushed rates high

ECB staff cut growth forecasts for 2026 from 0.9 to 0.8 percent, with that for 2027 being reduced from 1.3 to 1.2 percent. In 2028, they were unchanged at 1.5 percent.

These downward revisions are a “consequence of a stronger-than-expected war effect on commodity prices, real incomes and sentiment” according to the bank.

That tension between hotter prices and weaker output is the central challenge for Frankfurt. Hiking into a slowing economy risks compounding the damage when the source of inflation is a supply shock, not strong demand.

Lagarde pushed back when asked about the trade-off, saying growth in the euro area is not absent or under significant threat, and warning that letting inflation run further would make the return to target much harder.

The contrast with the last hiking cycle is sharper than the current numbers suggest. The ECB raised its deposit rate from negative 0.5% to 4% between June 2022 and September 2023 during the post-pandemic and Ukraine war inflation surge, then cut it back to 2% through a series of reductions ending in September 2025.

The 25 basis points added on Thursday, June 11, do not close that round trip. They restart the cycle.

Markets expect at least one more move, and the Fed is next

Deutsche Bank chief European economist Mark Wall stated “the cycle has little room to run “One more hike in September and that’s it “.

ING economist Carsten Brzeski took a slightly more hawkish view, arguing Lagarde’s emphasis on broadening inflation pressures pointed toward further action and that another move “either in July or September, has become more likely.”

Brzeski characterized the decision as the ECB “fighting ghosts from the past,” a reference to the criticism the bank faced for moving too slowly during the 2022 inflation surge.

Stephen Grissing, investment strategist at Davy, made the same point in different terms, noting the ECB had been criticized for reacting too slowly in 2022, when inflation had already climbed above 8% year on year, compared with 3.2% today.

Markets are pricing roughly even odds of another 25 basis-point hike by September. Neither the US Federal Reserve nor the Bank of England has moved rates in response to the Iran shock, though both meet next week. The eurozone’s heavier reliance on imported oil and gas left the ECB exposed first.

For tracker mortgage holders in the euro area, the hit is immediate. A borrower with a 150,000 euro loan and more than 10 years remaining faces an annual increase of just over 200 euros in repayments, according to Daragh Cassidy of Bonkers.ie.