The ECB raises interest rates to curb inflation caused by Trump

BrusselsThe European Central Bank (ECB) has decided to make a move to try to curb the rise in inflation caused by the war in the Middle East initiated by the United States and Israel. The rate of price increase in the eurozone has been moving away from Frankfurt's goal of keeping it at 2% annually for months, and finally, the financial institution has decided to act to prevent this percentage from growing further and has raised interest rates by 0.25 percentage points, to 2.25%.

will continue to have effects in the "medium term"will continue to have effects in the "medium term". Specifically, the ECB's economic forecasts published this Thursday revise upwards the price increase to 3% for 2026, and estimate that in 2027 it will already decrease to 2.3%. It is not until 2028 that the financial institution's calculations predict that inflation will meet the ECB's target and return to 2%, as it was before the attacks by the US and Israel on Iran.

This is the first time in almost three years that the ECB has decided to increase the price of money again. In 2022, the financial institution sharply raised the price of money – it went from 0% to 4.5% in just over a year – due to the energy and price crisis derived from the start of the war in Ukraine. Afterwards, however, it progressively reduced interest rates as inflation also decreased, until it reached the 2% considered appropriate.

In the same vein, Frankfurt warns that the increase in energy prices is "partially transmitted" to the inflation of food, goods, and services. And, for this reason, the ECB has also revised upwards the rate of core inflation – which excludes elements with the most volatile prices, such as energy or fresh food – and calculates that this year it will stand at 2.5%, while in 2027 and 2028 it will decrease slightly, until it stabilizes at 2.2%. "The big energy shock is lasting longer than geopolitical experts expected. [...] It is spreading throughout the economy," added Lagarde.

Slowing economy

The war not only negatively affects inflation, but also the economic activity of the countries in the single currency. ECB experts also worsen the growth prospects for the gross domestic product (GDP, the indicator that measures economic activity) of the eurozone and keep it in an almost anemic situation: this year, at 0.8%; in 2027, at 1.2%, and in 2028, at 1.5%. Lagarde attributed this to a "more pronounced impact of the war on commodity markets, real incomes, and market confidence".

The president of the financial body has avoided explicitly stating which path the ECB will take in the future and whether it will decide to raise or maintain interest rates at 2.25% in the coming months. Thus, Lagarde has limited herself to repeating, as is customary, that Frankfurt will continue to be based on future "inflation outlooks and the risks to which they are subject." However, the French leader has warned that the "outlooks remain uncertain," with "upside risks for inflation and downside risks for economic growth." "We are prepared to adjust all of our instruments at our disposal to ensure that inflation stabilizes sustainably at our medium-term objective," Lagarde added.

It should be recalled that raising the price of money is the financial body's main tool for curbing inflation, but it causes a slowdown in economic activity, as an increase in interest rates makes the cost for banks to borrow money more expensive and, at the same time, banking entities pass this on in the form of more expensive loans to their clients. And, naturally, if credit is more expensive, families and businesses find it more difficult to borrow from banks to consume or invest, which leads to a drop in demand and a reduction in the pace of the economy.

The ECB decided not to touch the price of money during the last seven meetings of the entity's governing council. Inflation remained under control and economic activity – as it currently is – was not picking up. Thus, there was no reason to touch interest rates, much less to raise them. Nevertheless, the war in Iran and the increase in fossil fuel prices have caused a rebound in inflation and, despite the ECB's initial cautious attitude, it has finally decided to increase interest rates and try to correct the inflationary trend suffered by the countries of the euro area.