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 price increase rate in the eurozone has been moving away from Frankfurt's target of keeping it at 2% 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 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. The financial institution sharply increased the price of money – it went from 0% to 4.5% in just over a year – due to the energy and price crisis resulting from the start of the war in Ukraine. Afterwards, however, it progressively reduced interest rates as inflation also decreased, until it reached 2%.

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 items with more 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, to stabilize at 2.2%. "The major energy shock is lasting longer than geopolitical experts expected. [...] It is spreading throughout the economy," added Lagarde.

The war not only negatively affects inflation, but also the economic activity of the single currency countries. ECB experts also worsen the growth prospects for the eurozone's gross domestic product (GDP) and maintain 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 institution has avoided explicitly stating which path the ECB will follow 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 base its decisions on future "inflation outlook and the risks to which they are subject." However, the French leader has warned that the "outlook remains uncertain," with "upside risks to inflation and downside risks to economic growth." "We are ready to adjust all 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 institution's main tool to curb 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 by making credit more expensive, raising the loans they give to their clients. And, naturally, if credits are more expensive, families and businesses find it more difficult to request loans from banks to consume or invest, which leads to a fall in demand and reduces 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 is currently the case – was not getting started. 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 raise interest rates and try to correct the inflationary trend suffered by the countries of the euro area.