ar
- The European Central Bank is expected to hike interest rates by 25 basis points for the first time since 2023, as higher energy prices push eurozone inflation up.
- The move comes despite weak growth, with policymakers balancing inflation risks against the danger of hurting an already fragile economy.
After last year’s 15% surge in the euro and inflation below target, Europe’s economy thought it would be the year of rate cuts.
Today, the outlook has shifted. Europe is now facing renewed inflation pressure from high energy prices. The latest inflation report showed a sharp surge, reversing the earlier trend when inflation had fallen below 2%.
The European Central Bank meets on Thursday, and it is expected to raise interest rates in what would mark its first hike decision since September 2023.
Inflation Forces the ECB’s Hand
Inflation across the eurozone jumped to 3.2% in May, surpassing far beyond the ECB’s target. Analysts now expect a 25-basis point rate hike, lifting the Main Financing Rate from 2.15% to 2.40%. ⁽¹⁾
Europe was particularly exposed to that shock, given its historic dependence on Russian energy supplies. In the years since, the region has worked to reduce that dependence and diversify its sources, but it has not escaped the vulnerability.
Today, Europe finds itself facing a fresh set of energy risks, this time stemming from the ongoing conflict in the Middle East.
Several ECB officials have been publicly preparing markets for the decision. Chief Economist Philip Lane signaled last month that a rate hike is on the way. He expects the ECB’s inflation forecasts to be revised upward at Thursday’s meeting.
Even dovish policymakers such as Italy’s Fabio Panetta and Greece’s Yannis Stournaras have backed the move. ⁽²⁾
A Difficult Balancing Act
The decision is not without controversy. Critics argue that tightening monetary policy now risks doing further damage to an already fragile economy.
The European Union cut its growth forecast for the eurozone last month to 0.9% for 2026, down from a prior estimate of 1.2%, while revised data showed the economy contracted 0.2% in Q1. ⁽³⁾
The risk is that raising rates in an already sluggish economy could deepen the slowdown, particularly at a time when rising energy costs from the Middle East conflict are already squeezing the region.
The debate has drawn comparisons to two earlier episodes that ended badly. In 2011, the ECB under President Jean-Claude Trichet raised interest rates twice, only for his successor Mario Draghi to reverse course toward the end of that year after the region fell into recession.
Policymakers at the time also reacted to commodity and energy price spikes but underestimated underlying weaknesses in the eurozone’s financial system.
The Risk of Doing Nothing
Despite warnings, the ECB looks committed to act on its move. Their concerns focus on inflation risk expectations being anchored, making it harder to bring them down.
Both hawkish board member Isabel Schnabel and dovish Greek central bank chief Yannis Stournaras have indicated they can no longer overlook the energy shock and that they must defend the ECB’s commitment to 2% inflation. ⁽⁴⁾
The ECB already made a huge mistake back in 2022, when it waited too long to hike rates. By the time the ECB reacted, Europe’s energy shock had dragged inflation up to 10.6%. ⁽⁵⁾
What Comes Next?
Markets expect one or two additional hikes to follow later this year, with the next move most likely coming in September. However, economists are divided. Only around 60% expect a second increase. ⁽⁶⁾
Investors will be watching ECB President Christine Lagarde’s post-decision press conference closely for any signals about the path ahead, though she is widely expected to offer little in the way of forward guidance.
Much will ultimately depend on how long the Strait of Hormuz remains closed and whether diplomatic efforts between the US and Iran can produce results.
