European Central Bank hikes key policy rates by 25 bps for first time in nearly 3 years

The European Central Bank has raised its key interest rates by 25 basis points, signaling its first such move in almost three years. This decision comes as the bank grapples with persistent inflation, exacerbated by the conflict in the Middle East and its impact on energy prices.

The ECB increased its deposit facility rate to 2.25%, the refinancing rate to 2.4%, and the marginal lending facility rate to 2.65%. The bank also revised its inflation projections upwards for 2026-2028, anticipating headline inflation to average 3.0% in 2026, 2.3% in 2027, and 2.0% in 2028. Projections for core inflation (excluding energy and food) also saw increases.

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In the baseline of the new Eurosystem staff projections, headline inflation is expected to average 3.0% in 2026, 2.3% in 2027 and 2.0% in 2028. For inflation excluding energy and food, the baseline foresees an average of 2.5% in 2026 and 2027 and 2.2% in 2028.

This rate hike occurs amidst growing concerns about economic growth within the 21-country currency bloc. Inflation remains above the ECB's 2% target. The bank has consequently lowered its economic growth projections for 2026 and 2027, forecasting an average of 0.8% in 2026 and 1.2% in 2027, with a slight increase to 1.5% in 2028. The central bank attributes the revised growth outlook to the war's impact on commodity markets, real incomes, and overall confidence.

Officials acknowledge the uncertain outlook, noting upside risks for inflation and downside risks for economic growth. The full extent of the war's impact on medium-term inflation and growth will depend on the duration and intensity of the energy price shock and its ripple effects. The ongoing closure of the Strait of Hormuz has significantly disrupted energy markets, contributing to global inflation concerns.

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The outlook remains uncertain, with upside risks for inflation and downside risks for economic growth. The full implications of the war for medium-term inflation and growth will depend on the intensity and duration of the energy price shock, as well as the scale of its indirect and second-round effects.