The European Central Bank raised its key interest rates by 25 basis points on Thursday amid upwardly revised inflation projections in the eurozone as the war in the Middle East drags on, pushing up energy prices.
As widely expected, the ECB will increase the deposit facility rate to 2.25%, while the interest rates on main refinancing operations and marginal lending facility will be bumped up to 2.40% and 2.65%, respectively, effective June 17. The interest rate hike marks the ECB's first since September 2023.
"The war in the Middle East is generating inflation pressures, and the decision to raise rates is robust across a range of scenarios mapping out how the shock might evolve and affect the medium-term outlook for the euro area," the central bank's Governing Council said.
Baseline inflation projections for 2026, 2027 and 2028 were also updated, with the Eurosystem staff forecasting average headline inflation of 3%, 2.3% and 2%, respectively. Meanwhile, the average core inflation estimates were 2.5% in 2026 and 2027, and 2.2% in 2028.
In March, staff's average headline inflation expectations stood at 2.6% in 2026, 2% in 2027 and 2.1% in 2028, while average core inflation forecasts over the three-year period were anticipated to be 2.3%, 2.2% and 2.1%.
Based on the latest flash estimates from Eurostat, the annual inflation rate in the euro area edged up to 3.2% in May from 3% in the previous month, with the core rate, which excludes energy, food, alcohol and tobacco, rising to 2.5% from the prior 2.2%.
"Since inflation in the euro area is above three percent and there is little hope for a de-escalation of the Iran conflict, an interest rate increase is the right move now," ifo Institute President Clemens Fuest said in a note following the rate hike. "The ECB is thus following what the markets have already priced in."
The ECB said the outlook remains uncertain and that it will keep a close eye on the situation, with the war's full implications for medium-term inflation and growth depending on the length and intensity of the energy price shock and the magnitude of its indirect and second-round effects.
"With today's decision, the Governing Council remains well positioned to navigate the uncertainty caused by the war," the central bank said.
