ECB hikes rates for first time in 3 years as Iran war fuels inflation

The European Central Bank raised interest rates on Thursday, lifting its deposit facility rate by 25 basis points to 2.25% in what marks the institution's first hike in nearly three years as the war in Iran drives energy prices and inflation across the eurozone higher.euronews+1

A Hawkish Pivot

The move, which had been telegraphed for weeks and was fully priced in by markets, also saw the main refinancing rate rise to 2.40% and the marginal lending facility rate increase to 2.65%. It represents a decisive end to the easing cycle that characterized ECB policy through much of 2024 and 2025, when rates were cut steadily from their post-pandemic highs.euronews

"The situation in the Middle East is creating inflationary pressures, and our decision to raise rates is solid across various scenarios regarding how this shock may develop and influence the medium-term outlook for the eurozone," the ECB said in its statement. The central bank also revised its 2026 inflation forecast upward to 3.0% from the 2.6% projected in March, and raised its 2027 forecast to 2.3% from 2.0%.Reuters

Stagflation Fears Mount

The rate hike comes as the eurozone faces a troubling combination of rising prices and weakening growth. Eurozone inflation accelerated to 3.2% in May — the highest since September 2023 — driven by a 10.9% surge in energy costs linked to disruptions in the Strait of Hormuz, according to Eurostat data. Core inflation, which strips out energy and food, also rose unexpectedly to 2.5%.CNBC+2

Meanwhile, the bloc's economy contracted 0.2% in the first quarter of 2026, revised sharply downward from initial estimates of 0.1% growth, marking the first quarterly decline since late 2022. The contraction was heavily influenced by a 12.1% plunge in Irish GDP, though France also shrank and fixed investment fell across the bloc.TRADING ECONOMICS+2

What Comes Next

A Reuters poll found that more than 60% of economists expect a further rate hike in September, while markets are pricing roughly a 50% probability of that move. ECB President Christine Lagarde Euronext N.V. was due to address reporters at 14:45 CET on Thursday, where she was expected to outline the Governing Council's forward guidance.reuters+2

Bank of America economist Ruben Segura-Cayuela expects two quarter-point increases in June and July, taking the deposit rate to 2.5%, though he acknowledges weaker economic data could push the second move to September. The central question now facing policymakers is whether the eurozone's fragile economy can withstand tighter monetary policy even as energy-driven inflation shows no sign of abating.Euronews