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The European Central Bank held interest rates steady on Thursday, but investors expect it will push borrowing costs higher in the coming months to contain inflation driven by the war in the Middle East.
The central bank left rates at 2.25%, as widely expected by markets, after lifting them for the first time in almost three years last month. Global oil prices have jumped back toward $100 a barrel as tensions escalate in the Strait of Hormuz, reigniting the risk of war-induced inflation pressures.
The key point
The ECB’s pause will give policymakers time to assess how the collapse of the June U.S.-Iran ceasefire will impact inflation. Renewed fighting has sent oil and natural-gas prices back up, threatening to drive inflation further away from the ECB’s 2% target. Consumer price growth in the eurozone eased to 2.8% in June, from 3.2% in May, after the ceasefire initially drove down energy prices.
“Uncertainty remains high and the full inflationary impact of the energy shock has yet to play out,” the ECB said in its policy decision Thursday. The central bank said the outlook for energy prices remains close to its June baseline forecasts.
ECB policymakers are watching closely for signs that higher energy costs have filtered through to other parts of the economy, which would reinforce their case for keeping interest rates higher.
“When you see inflation picking up in the way it is, broadening throughout the economy…to us this is inflation that needs to be taken into account and that needs to be addressed,” ECB President Christine Lagarde said last month.
European bond yields have surged alongside energy prices, sending government borrowing costs to their highest levels in more than a decade. Germany’s 10-year government bond yield climbed toward 3.2% this week, the highest since 2011. France’s benchmark borrowing costs topped 4%, a level last seen in 2009.
The context
The ECB has moved faster to confront energy-price-induced inflation than the Federal Reserve or Bank of England, which have yet to raise interest rates since the war started in late February. Investors mostly expect the Fed and BOE to hold rates steady when they meet next week, though traders are betting both central banks will join the ECB in raising rates in the coming months.
The ECB has more room to lift borrowing costs because its benchmark policy rate sits more than a percentage point lower than its peers, and is still within a range that many economists view as neutral for the economy—neither stimulating nor restricting growth. The Fed’s target policy rate range is 3.5% to 3.75%, while the BOE’s bank rate is 3.75%.
What comes next
Investors are betting the ECB will raise rates twice more this year: when it meets next in September and again in December, according to derivatives markets.
Still, Lagarde has said the central bank likely won’t need to act as forcefully to contain inflation as it did during the 2022 energy crisis. The rise in energy prices, particularly for natural gas, was much larger back then, and the economy was still benefiting from a postpandemic rebound in demand.
Threats to economic growth are also mounting, with a flood of cheap imports from China threatening key industries such as Germany’s auto sector.
At a press conference following the decision, Lagarde is also likely to face questions about her commitment to finishing out her term, set to end in October 2027. Lagarde said earlier this month that she could depart early to play a role in next year’s French election to replace President Emmanuel Macron.
Write to Chelsey Dulaney at [email protected]