Lagarde defends ECB rate hike as eurozone braces for inflation from Iran conflict

The June 11 decision

Lagarde pushed back against descriptions of the rate hike as a “precautionary measure,” insisting it was solidly grounded in data. She pointed out that without the increase, inflation would have stayed above the ECB’s 2% target in both 2027 and 2028. “Our rate hike was justified in all scenarios considered,” she said.

The interest rate hike was justified in all scenarios considered. It was a deliberately solid decision. And nothing observed since then has cast doubt on this assessment.

The central bank raised its key rate by 25 basis points to 2.25% on June 11, its first increase since September 2023. Lagarde framed the move as a return to basics, with the policy rate as the main instrument for stabilizing inflation, and no need for unconventional tools.

Europe’s new shock absorber

A more resilient eurozone economy now gives the ECB room to calibrate rate moves without triggering financial stress, Lagarde argued. The bloc has beefed up its institutional architecture with joint supervision and other instruments, and the economy has absorbed supply-side shocks better than in past crises.

While we are more likely to face shocks that push inflation away from target, the resilience Europe has built means their effects on our economy are more contained.

That resilience allowed the ECB to become the first major central bank to raise rates after the Iran war began, Lagarde noted. She stressed that policy can now respond with “moderate adjustments” rather than the aggressive tightening seen during the 2022–2023 inflation surge.

Iran conflict and oil volatility

The energy shock from the Middle East conflict has upended the eurozone’s hard-won disinflation. Inflation hit 3.2% in May, well above target, and oil prices have swung wildly, breaching $120 per barrel before retreating to around $70. Lagarde warned that a diplomatic resolution is far from assured.

The durability of this agreement is not guaranteed.

She also flagged the unpredictable nature of geopolitical responses, observing that the negative impact of trade tariffs had been partly offset by a surge in defense spending, an unforeseen positive demand shock. The ECB, she said, must remain ready to act if inflationary pressures reignite.

Forecasting and data-driven policy

Lagarde credited the ECB’s investment in data and projection models for giving it confidence to move in an uncertain environment. Forecast errors had been very small since the Iran conflict erupted, she said, thanks to improvements in oil, gas, and electricity price modelling made after the 2022 inflation spike.

We can continually cross-check our forecasts against incoming data to verify whether they remain on track, so that we do not end up relying on out-of-date projections.

Financial markets price in policy moves well before official decisions, she added, which buys the ECB time to sift through data and act only after a careful assessment. This transmission mechanism is especially valuable when uncertainty is high.

The path ahead

Markets and analysts now expect two or three additional rate increases this year, which would lift the deposit rate from 2.25% to around 2.75%. Lagarde did not commit to a timetable, stressing that decisions will be taken meeting by meeting. ECB board member Isabel Schnabel recently told Die Zeit that further rate rises are needed to bring inflation back to target.

The wider outlook remains clouded. The ECB projects eurozone GDP growth of 0.8% this year, 1.2% in 2027, and 1.5% in 2028. But the persistence of high uncertainty means Lagarde’s “intermediate zone” between shocks the ECB can look through and those it must fight may become a permanent feature of policy making.