ECB raises interest rates as Iran war fans inflation fears

By Reinhard Becker

BERLIN, Sept 10 (Reuters) – The European Central Bank raised interest rates on Thursday for the second time this year, seeking to quell an energy-driven rise in inflation triggered by the Iran war even as it warned that fuel prices could move higher.

A month of relative calm has been shattered since end-August as the U.S. and Iran hit military, shipping and energy assets, sending oil back above $100 a barrel and reviving fears about a wave of price hikes in the fuel-importing euro zone.

The ECB responded by raising its policy rate to 2.50% from 2.25%. It acknowledged that even then inflation was expected to stay above its 2% goal through to 2028, in part because activity in the wider economy was proving to be resilient.

The ECB decision and statement prompted traders to raise bets on further hikes, pricing in 60 bps more of increases by the April 2027 meeting, up from around 51 bps beforehand.

As usual, ECB President Christine Lagarde stressed the bank did not pre-commit to any future moves.

“We have not debated at all any kind of future path,” she told a press conference. “Markets do what they have to do and we do what we have to do – which is to provide price stability.”

Economists ahead of the meeting said Thursday’s move was likely to be the ECB’s last for now, although a growing number saw a risk that further tightening may now be needed.

“More important than the move itself is that the ECB has used this meeting to acknowledge a stronger economy and a more persistent inflation outlook than it expected just a few months ago,” said Aberdeen economist Felix Feather.

HIGHER GROWTH AND INFLATION EXPECTATIONS

The central bank for the 21 countries that share the euro currency slightly raised some growth and inflation projections, reflecting the economy’s greater-than-expected resilience and the effect of higher fuel costs on other prices. 

The ECB now sees inflation at 3.0% this year, 2.5% next year and 2.1% in 2028 — a 20-basis point rise in the 2027 forecast and a 10-basis point increase for the 2028 figure.   

But Thursday’s projections are unlikely to fully capture the latest energy-price surge, particularly in natural gas, which many European countries rely on for heating.

Lagarde explicitly acknowledged that gas prices could rise due to further supply disruptions or an unusually cold winter in combination with low storage levels across much of the region.

“We believe inflation will be longer lasting than we had anticipated,” she said.

RESILIENT ECONOMY PROVIDES COMFORT 

Lagarde and colleagues, gathering in Berlin for their annual venture away from the central bank’s Frankfurt headquarters, are likely to have taken comfort from recent growth data.

The euro zone economy has been holding up better than anticipated despite higher fuel costs, competition from China and the impact of droughts.

Bank lending even picked up pace in July, suggesting the ECB’s June rate rise had not dented activity and giving policymakers scope to tighten further on Thursday.

The ECB now expects the euro zone economy to grow by 0.9% in 2026, 1.4% in 2027 and 1.5% in 2028.

But policymakers will be watching a rise in government borrowing costs that has already tightened financing conditions.

Long-term bond yields have scaled highs not seen since before the global financial crisis, reflecting inflation concerns and worries about ballooning government debt. 

Competition from bond sales by tech companies aggressively raising money to fund the AI boom has added to upward pressure on yields, while political turmoil in Germany has shaken its government bonds, the benchmark for the euro zone.  

BURDEN OF PROOF IS ON THE DATA

The economic indicators the ECB watches have so far been broadly benign.

Core inflation, which strips out energy and food prices, eased to 2.4% last month and the latest survey showed consumers had trimmed their expectations for price growth. Pay rises had also moderated.

“Unlike the 2022 energy shock, this year’s energy price shock is unlikely to spark a wage-price spiral, as demand conditions are not as conducive to higher inflation,” Andrew Kenningham at Capital Economics said.

ING’s global head of macro Carsten Brzeski said companies, at least in Germany, had so far absorbed the higher costs, in marked contrast to 2022, when the energy shock following Russia’s invasion of Ukraine pushed inflation above 10%.

(Additional reporting by Balazs Koranyi and Francesco Canepa in Frankfurt; Editing by Catherine Evans)