The European Central Bank is poised to raise interest rates for the first time in nearly three years on Thursday, as surging energy prices linked to the Iran war have pushed eurozone inflation well above its 2% target and narrowed the bank’s options.
How the Iran War Reshaped the ECB’s Rate Calculus
The Frankfurt-based institution is widely expected to raise its key interest rates by 25 basis points, taking the deposit facility rate to 2.25% from 2.00%.
Such a move would mark the first rate increase since September 2023.
The shift is sharp. Prior to the outbreak of the conflict in Iran, eurozone inflation had dipped below the 2% threshold.
That changed fast. Energy prices rose 4.9% year-on-year in March, reversing a 3.1% decline in February.
Brent crude climbed more than 50% to above $100 a barrel since the escalation of the conflict involving Iran in late February.
Iran has severely disrupted tanker traffic through the Strait of Hormuz, a key waterway that normally carries about 20% of the world’s oil and gas, following US-Israeli joint strikes.
The European Commission confirmed the scale of the supply shock in its Spring 2026 Economic Forecast: between February 27 and April 29, gas prices increased by 50% and crude oil prices by 65%, while refining margins for diesel and jet fuel reached historically elevated levels.
What Stickier Services Costs Mean for Borrowers
Headline inflation is only part of the problem. Core inflation also rose to 2.5% in April, primarily driven by higher services costs.
Eurozone inflation jumped to 3% in April, then rose further to 3.2% in May, with energy price inflation running 10.9% year-on-year.
ECB staff minutes from the March 2026 meeting noted that domestic and services inflation remained elevated.
Officials also flagged that uncertainties tied to tariffs and energy price developments risked making firms less willing to absorb shocks through profit margins, raising the likelihood they would pass costs on to consumers.
Those pressures informed a pivotal April decision. The ECB left rates unchanged while signalling rising concerns over soaring inflation.
President Christine Lagarde said a possible rate hike had been discussed “at length” by policymakers, adding that their June meeting would be the “right time” for a new assessment.
From “Good Place” to Near-Certain Hike
Lagarde subsequently signalled the ECB will revise its inflation forecasts upward at the June meeting.
Governing Council member Alexander Demarco told Bloomberg that the March forecast, published shortly after the Iran war broke out, may have been too optimistic.
Markets and economists are broadly pricing in a quarter-point hike, with several council members suggesting it may be unavoidable without a lasting US-Iran peace agreement.
Markets are currently pricing in a 94% chance of a 25 basis point hike at the June 11 meeting, according to LSEG data.
Sven Jari Stehn, chief European economist at Goldman Sachs, wrote that ECB staff are expected to mark down growth projections for 2026-27 and raise both headline and core inflation projections, reflecting a more persistent energy shock and stronger indirect effects on prices.
Despite the expected hike, the ECB is unlikely to provide explicit forward guidance.
Policymakers continue to stress a data-dependent approach, reflecting exceptional uncertainty surrounding the geopolitical situation and future energy prices.
Not all analysts see an extended tightening cycle ahead. Nomura forecasts ECB rates will remain unchanged through 2027 as inflation stays near target.
However, tight labor markets and above-potential growth risk pushing inflation higher in 2028, likely requiring at least two rate hikes to restore price stability.
