ECB raises deposit rate to 2.50% as Middle East war elevates inflation projections

Rate hike and meeting in Berlin

The European Central Bank raised its benchmark interest rates by 25 basis points on Thursday, lifting the deposit facility rate to 2.50%. The main refinancing operations rate increased to 2.65% and the marginal lending facility rate reached 2.90%. Rate-setters took the decision at a meeting held in Berlin rather than at the institution's Frankfurt headquarters. The adjustment represents the ECB's second rate increase of 2026, following an initial hike on June 11 and a pause on July 23. ECB President Christine Lagarde noted that the decision was unanimous, while declining to pre-commit to actions at future sessions.

Inflation projections and energy pressures

Rising energy costs tied to the war between the United States and Iran prompted the central bank to adjust its medium-term inflation outlook upward. Headline inflation across the 21 eurozone economies stood at 3.3% in August, driven by reduced oil tanker traffic through the Strait of Hormuz and higher gas prices. The ECB maintained its 2026 inflation projection at 3.0%, but lifted its 2027 forecast to 2.5% from 2.3% in June and its 2028 forecast to 2.1% from 2.0%. Core inflation projections, which exclude food and energy, increased to 2.6% for 2027 and 2.3% for 2028. Lagarde addressed the inflationary environment during her post-meeting press conference.

The conflict in the Middle East continues to generate inflation pressures, and inflation is set to remain well above target for an extended period.

Economic growth and labor resilience

Alongside higher inflation estimates, the central bank raised its eurozone economic growth projections. Gross domestic product is now projected to expand by 0.9% in 2026, up from the 0.8% estimated in June, and 1.4% in 2027, up from 1.2%, before reaching 1.5% in 2028. Central bank staff observed that household consumption, capital investment, and industrial production have adapted quickly despite elevated energy expenses. Furthermore, a relatively soft labor market has contained the development of a wage-price spiral. Lagarde addressed the broader economic performance across member states.

The economy proved resilient in the second quarter, despite headwinds from the energy shock. Growth was broad-based across countries and sectors. This pattern is likely to have continued into the third quarter.

Market reactions across debt and equities

Financial markets reacted to the policy statement and surging energy commodities with bond yield increases and equity declines. Brent crude oil rose more than 4% on Thursday to $105.51 a barrel, while European natural gas prices touched levels unseen since 2022. Germany's 10-year bond yield reached its highest mark since 2011, and France's 30-year yield rose to levels last recorded in 2003, with French sovereign borrowing costs nearing 4.4%. The pan-European STOXX 600 equity index dropped 0.6%, Germany's DAX 40 fell 0.7%, France's CAC 40 slid 0.5%, and the euro weakened against the US dollar to $1.1625. Money markets increased expectations for cumulative monetary tightening by end-2027 to 85 basis points.

Hawkishness in terms of the forecasts, as well as nothing in speech to change this narrative, has validated the market behavior that rates have to follow energy prices.

Next monetary steps and central bank schedule

Policymakers will convene next on October 29, with options remaining open for another rate increase before year-end. Central bank sources indicated that another adjustment could occur at that October meeting depending on incoming inflation data and conflict developments in the Middle East. A rate hike by December is fully priced in by money markets following Thursday's decision. Central bankers in other major economies face parallel dilemmas, with the US Federal Reserve scheduled to meet on September 15 and 16 to evaluate US inflation running at 3.7%.