The ECB resumes the interest rate hike and anticipates a scenario of "uncertainty"

BrusselsBuying a car in installments, taking out a loan to renovate a house, or financing a business investment will be a little more expensive. The European Central Bank (ECB) has decided to increase interest rates by a quarter of a percentage point, to 2.5%, with the aim of curbing the price escalation caused by the war in Iran.

To take this measure, it has taken into account the increase in inflation in the eurozone, which has reached its highest level since the autumn of 2023 due to the impact of the conflict on energy markets and the forecast that this situation will drag on. The Frankfurt institution, which met this Thursday in Berlin, has warned that it expects inflation to remain above the 2% target "longer than expected." The decision, it maintains, "underscores the commitment" to establish a monetary policy "that ensures that inflation stabilizes at its 2% target in the medium term."

The organization has long been navigating the difficulty of predicting how the economy will evolve due to external factors, which depend on highly volatile geopolitical reasons. As it acknowledges in the statement, the economic outlook is uncertain and it is necessary to take into account "upside risks for inflation and downside risks for economic growth." "We are in a moment of uncertainty in which things can change almost from one day to the next," said the president of the ECB, Christine Lagarde, in a press conference. For this reason, "we cannot anticipate what the next move will be," she said. But she warned that the longer energy prices remain high, the more likely they will be to push up general inflation "through indirect effects and second-round effects."

Prices have been climbing for almost three years, and have skyrocketed due to the rising cost of energy following the closure of the Strait of Hormuz. Driven by the energy sector –which generates chain effects on the entire price structure–, general inflation has risen to 3.3%. For its part, core inflation (which excludes the most volatile sectors, such as energy and food) remains stable and stands at around 2.4%, a figure close to the average of the last year and close to the 2% target set by the ECB. With the increase in interest rates, the monetary institution hopes to curb the escalation of prices, without further weakening an already fragile economy.

This is the second rate hike to be applied this year. The central bank shared by the 21 countries of the eurozone raised them in June for the first time since September 2023. At that time, it justified the move due to the "major energy shock," which was lasting "longer than expected" and had an impact on prices. Afterwards, in July, the ECB opted for caution and decided to keep them steady to have room to "address the uncertainty caused by the conflict" in the Middle East.

With the new rates at 2.5%, the limit of what the institution itself sets as a neutral range is reached, meaning it is believed that it does not have excessive effects on the economy. Regarding this, Lagarde has assured that this threshold is "very conceptual" and that, in current circumstances, it should not be taken into account.

The problem Frankfurt faces is that the current uptick in inflation has a cause over which interest rates have little ability to influence: the rising cost of energy. Prices are rising due to a supply shock: energy has become more expensive because the conflict has hindered its supply, not because the demand from families and businesses has skyrocketed. And raising interest rates will not lower the price of oil. The ECB's action, therefore, aims to prevent the energy shock from spreading to the rest of the economy, but without further cooling an activity that is already showing signs of weakness.

Resilience of the European economy

The ECB has also made public its new economic projections. It maintains that headline inflation will stand at 3.0% on average in 2026, but raises the forecasts for the year 2027 (2.5%) and for 2028 (2.1%). Regarding core inflation –excluding energy and food–, it forecasts 2.5% in 2026, 2.6% in 2027, and 2.3% in 2028. The president of the organization also expressed being "perplexed" by the evolution of food prices in comparison with energy. "We have revised the price of food downwards compared to what we had assumed: 14.3% for energy and 2.1% or 2.2% for food," she assured.

Lagarde stated that the ECB economists were "surprised" by the resilience of the European economy and its ability to adapt to the inflation context. For this reason, they have revised the projections for economic growth upwards. They expect the economy to grow by 0.9% in 2026, 1.4% in 2027, and 1.5% in 2028. The new estimates reflect a "greater resilience than expected of the eurozone economy," the organization asserts.

The president of the European Central Bank insisted on Wednesday, in a speech at the official Bundesbank dinner, on the need for a more united European Union "in a tougher and less forgiving world," increasingly conditioned by major powers. For Lagarde, the continent faces a dilemma "about who we are as Europeans," for which she sees three outcomes. The first, to accept that Europe's decline is "inevitable." The second, that each country pursues its own national economic interests. And the third, her proposal: "To choose each other and continue with the task of building Europe."