The European Central Bank (ECB) on Thursday raised its benchmark interest rate for the first time since 2023, as the Middle East conflict fuels inflationary pressures, despite concerns the move could further strain the struggling eurozone economy.
The ECB increased its deposit rate by 0.25 percentage points to 2.25 percent, becoming the first major central bank to tighten monetary policy in response to the energy shock triggered by the conflict.
Eurozone inflation has accelerated since the onset of the US-Israeli war against Iran, rising to 3.2 percent in May—above the ECB’s two percent target.
Announcing the decision, the ECB said “the war in the Middle East is generating inflation pressures.”
“The outlook remains uncertain, with upside risks to inflation and downside risks to economic growth,” it added in a statement.
The bank warned that the medium-term impact on inflation and growth would depend on the intensity and duration of the energy price shock, as well as its indirect effects.
The ECB also revised its forecasts, raising its inflation projection for this year to 3 percent from 2.6 percent in March, while lowering its eurozone growth outlook to 0.8 percent from 0.9 percent.
Tensions surrounding the Strait of Hormuz—a key global oil and gas transit route—remain high, with limited passage amid ongoing conflict and renewed strikes in the region.
First move since 2023
While some smaller central banks have already reacted to the energy shock with rate hikes, major institutions including the US Federal Reserve and the Bank of England have so far held steady as they assess the economic fallout ahead of meetings next week.
For the Frankfurt-based ECB, Thursday’s increase marks its first rate hike since September 2023, when policymakers were battling inflation driven by Russia’s invasion of Ukraine. The bank later shifted to rate cuts as inflation eased, holding rates steady since June last year.
Higher interest rates typically cool inflation by reducing demand, but economists warn this move may have limited effect on price pressures driven largely by energy supply constraints rather than consumer demand.
Growth concerns
Rising borrowing costs are expected to weigh further on the eurozone economy, which contracted in the first quarter amid weakness in Ireland.
Households and businesses are already facing elevated energy costs, adding to economic strain across the 21-member currency bloc.
Some analysts argue ECB policymakers may be acting cautiously to avoid a delayed response, recalling criticism over its slow reaction to the inflation surge in 2022. However, others note the current environment differs, with inflationary pressures more supply-driven and global growth already fragile.
Investors will closely watch ECB President Christine Lagarde for guidance at her upcoming press conference, though she is expected to avoid signalling a clear policy path.
Most analysts do not expect Thursday’s decision to mark the beginning of a sustained tightening cycle.
AFP
