Key Takeaways:
- ECB expected to deliver 25bp hike to 2.25% on Thursday
- Eurozone inflation accelerated to 3.2% in May, above 2% target
- Economists see limited scope for further tightening amid weak growth
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ECB set to raise rate to 2.25% as Iran war fuels inflation
The European Central Bank is poised to deliver its first interest-rate increase in almost three years on Thursday, responding to an energy-driven inflation spike from the Iran conflict that threatens to outpace a weakening eurozone economy.
The ECB is set to raise its deposit rate by a quarter point to 2.25% on Thursday, becoming the first major central bank to tighten policy in response to the Iran war's energy shock as eurozone inflation accelerated to 3.2% in May.
"Anything but a rate hike at the ECB meeting would be a big surprise," said Carsten Brzeski, global head of macro at ING. "It will be an insurance hike after the criticism the ECB was slow to act in 2022."
Consumer prices in the 21-country eurozone rose 3.2% in May from a year earlier, up from 3% in April and well above the ECB's 2% target, preliminary data showed. Core inflation, which strips out volatile components such as energy and food, accelerated to 2.5% from 2.2%. Futures markets implied a roughly 97% probability of a quarter-point increase, according to Bloomberg data, while more than 90% of economists in a Reuters poll expected the move.
The rate decision comes as the eurozone economy contracts — revised data Friday showed GDP shrank 0.2% in the first quarter — and the European Union last month cut its 2026 growth forecast to 0.9% from 1.2%. Economists broadly see limited scope for further tightening, with 60% of those polled by Reuters expecting one additional hike, likely in September, to bring the deposit rate to 2.50%.
The ECB's expected move marks a sharp reversal from the easing cycle that began in June 2024, when the central bank started cutting from a peak of 4% after inflation receded from the double-digit highs triggered by Russia's invasion of Ukraine. Eight consecutive cuts brought the deposit rate to 2% by June 2025, where it remained for a full year before the Iran conflict upended the outlook.
The war and the near-total closure of the Strait of Hormuz have pushed global energy costs sharply higher, feeding directly into eurozone inflation. The region is heavily dependent on energy imports, making it particularly vulnerable to the supply shock.
"The June rate increase would mainly serve to preserve the ECB's anti-inflation credibility and help anchor expectations," said Martin Wolburg, senior economist at Generali Investments. "But with hopes for a peace deal in the Iran conflict fading and stagflation risks remaining elevated, President Christine Lagarde will likely want to keep the door open to further tightening if needed."
Growth vs. Inflation Trade-Off
The ECB's new macroeconomic projections, due alongside the rate decision, are expected to show significantly higher inflation estimates for 2026 and 2027, according to economists at DWS and BNP Paribas AM. The March projections forecast 2.6% inflation for 2026, but consensus estimates now stand at 2.9%.
"Assuming that oil prices do not return to preconflict levels anytime soon, inflation estimates for 2026 and 2027 will need to be revised significantly upward," said Ulrike Kastens, senior economist at DWS. At the same time, the S&P Global eurozone Composite PMI fell to 48.5 in May, marking back-to-back months of contraction for the first time since late 2024.
Raphaël Gallardo, chief economist at Carmignac, cautioned that the situation differs from 2022. "The profit-employment nexus is way less powerful today than in 2022 and looser job markets imply weaker workers' bargaining power, limiting the scope of tightening to two summer hikes," he said.
Market Reaction and Forward Path
Eurozone government bond yields have risen sharply this year as rate expectations shifted from further cuts to an increase. The 10-year German Bund yield trades near 3%, reflecting higher issuance, fiscal concerns and an uncertain growth outlook. An increase in interest rates typically pushes yields higher and bond prices lower.
Alessandro Tentori, chief investment officer Europe at BNP Paribas AM, said the ECB "will continue to frame policy as data dependent, and it is increasingly focused on second-round effects across wages, core inflation and broader price formation." His base case calls for two quarter-point hikes — in June and September — followed by an extended hold through end-2027.
The ECB's next policy meetings are scheduled for July 23, Sept. 10, Oct. 29 and Dec. 17. Unlike the Federal Reserve and the Bank of England, which have kept rates on hold as they assess the conflict's fallout, the ECB is moving first — a decision that carries risks for a region already tipping toward recession.
This article is for informational purposes only and does not constitute investment advice.
[1] Decision Time: European Central Bank[2] ECB Expected to Be First Among Peers to Raise Key Rate in Response to Conflict - WSJ[3] ECB Rate Decision: What to Expect on June 11 | Morningstar Nordics[4] ECB to hike rates as Mideast war pushes up inflation[5] European Central Bank (ECB) Advances Digital Euro While Safeguarding Cash Access...
