The European Central Bank has hiked its key interest rate by a quarter point to 2.25%, marking its first rate rise since 2023 amid ongoing inflationary pressure from the Iran war.
The ECB’s Governing Council confirmed Thursday that the decision was driven by the need to counter inflationary pressures generated by the U.S.-Iran war, which has now crossed the 100-day mark.
Markets had been pricing in a near-100% chance of a rate rise of at least 25 basis points ahead of the June Governing Council meeting, according to LSEG data.
“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 bank said in a statement.
The closure of the Strait of Hormuz and destruction of energy production facilities in the Middle East have created severe supply constraints, sending energy costs sharply higher across the region.
The ECB also raised its inflation forecasts, now expecting headline euro zone inflation to average 3% in 2026, before cooling to 2.3% in 2027 and reaching its 2% target in 2028.
Economic growth forecasts were revised downward, with the ECB now projecting euro zone growth of just 0.8% in 2026, rising to 1.2% in 2027 and 1.5% in 2028.
Officials said the weaker growth outlook reflected “a more pronounced impact of the war on commodity markets, real incomes and confidence,” signalling the breadth of the conflict’s economic consequences.
ECB President Christine Lagarde told reporters Thursday afternoon that uncertainty remains significant, stating: “The outlook remains uncertain, with upside risks for inflation, and downside risks for economic growth. We are not pre-committing to a particular rate path.”
Lagarde added that “the full implications of the war for medium-term inflation and growth will depend on the intensity and duration of the energy price shock, as well as the scale of its indirect and second-round effects.”
Euro zone inflation rose to 3.2% in May, driven by higher energy costs pushing the headline rate further above the ECB’s 2% target, while the bloc’s economy grew by just 0.1% in the first quarter.
Mark Wall, chief European economist at Deutsche Bank, described the hike as “a significant moment,” noting it is also the first rate rise by a major global central bank in direct response to the energy shock.
“The ECB is saying that a ‘look through’ strategy is not a robust response. The question is how far can this tightening cycle go? Not far, is our answer,” Wall said in a note, predicting one further hike in September before the cycle ends.
Neil Birrell, chief investment officer at Premier Miton, said the decision was unsurprising given the inflation backdrop, adding: “This is likely to be followed by more rate hikes this year, depending on the data, but it’s hard to think this is the end of the policy move.”
The yield on the 10-year German bund was 2 basis points lower by 2:50 p.m. in Frankfurt, while the euro held flat against both the dollar and the British pound following the announcement.