ECB Raises Rates to 2.50% as Iran War Drives Inflation Above Target Through 2028
The European Central Bank increased its policy interest rate by 25 basis points to 2.50% in response to energy-driven inflation caused by the Iran war, which has pushed oil prices above US$100 a barrel. Despite the hike, the ECB projects inflation will remain above its 2% target through 2028, while market traders anticipate further increases.
The European Central Bank (ECB) raised its policy interest rate from 2.25% to 2.50% on Thursday, marking a decisive move to combat inflation fueled by rising energy costs linked to the conflict in Iran. The geopolitical tensions have sent oil prices back above US$100 a barrel, reviving fears of price hikes across the fuel-importing euro zone.
Despite the rate increase, the ECB’s latest projections indicate that inflation will persist above the bank’s 2% goal for several years. The central bank now expects inflation to reach 3.0% this year, 2.5% next year, and 2.1% in 2028. These forecasts represent upward revisions, with the 2027 projection raised by 20 basis points and the 2028 figure increased by 10 basis points compared to previous estimates.
ECB President Christine Lagarde acknowledged that inflation would be longer-lasting than initially anticipated but stated that the bank did not pre-commit to any future moves. While core inflation eased to 2.4% last month and pay rises have moderated—reducing the risk of a wage-price spiral similar to the 2022 energy shock when inflation hit 10%—policymakers warn that gas prices could rise further due to supply disruptions or cold weather.
Market reaction suggests investors are bracing for more tightening. Following the decision, traders priced in approximately 60 basis points of additional rate increases by the April 2027 meeting, up from 51 basis points previously. This shift reflects growing concern over the persistence of energy-driven price pressures.
On the economic front, the euro zone shows signs of resilience. The ECB projects growth of 0.9% in 2026, rising to 1.4% in 2027 and 1.5% in 2028. However, broader financial conditions are tightening. Long-term bond yields have scaled highs not seen since before the global financial crisis, driven partly by competition from tech company bond sales and political turmoil in Germany, which has shaken its government bonds. Consequently, government borrowing costs have risen, impacting financing conditions across the region.