ECB Conducts Widely Expected Rate Hike. The Next Move Is Less Clear.

The ECB raised interest rates on Thursday, noting that the war between the U.S. and Iran keeps putting pressure on prices.

The benchmark rate now stands at 2.5% compared to the previous 2.25%. The body noted in a statement that the decision "underscores the Governing Council's commitment to setting monetary policy to ensure that inflation stabilises at its 2% target in the medium term."

The body went on to say that its baseline projections now stand at 3% this year, 2.5% in 2027 and 2.1% in 2028. Core inflation, in turn, is set to be stickier: "the baseline foresees 2.5% in 2026, 2.6% in 2027 and 2.3% in 2028. Compared with June, the baseline projection for inflation in 2026 is unchanged, while it has been revised up for 2027 and 2028," the document says.

The ECB warned that outlooks remain "highly uncertain, with risks to the upside for inflation and to the downside for economic growth."

"In relation to the energy shock, the updated scenarios put together by staff illustrate the broad range of outcomes for how growth and inflation would evolve under different assumptions about its intensity and duration, as well as its indirect and second-round effects," the document adds.

Staffers concluded that the decision leaves the Governing Council "well positioned to navigate the uncertainty caused by the conflict." However, it added that it "stands ready to adjust all of its instruments within its mandate to ensure that inflation stabilises at its 2% target in the medium term and to preserve the smooth functioning of monetary policy transmission."

The decision came after inflation in the euro zone climbed back above 3% in August, fueled by energy prices. Concretely, headline inflation rose 0.4 percentage points and clocked in at 3.3% in August, compared to 2.9% the month prior. It is the highest level since September 2024, Eurostat said.

Energy plays a significant role in European prices, considering the area is a net importer. In this context, energy inflation soared to 14.3% from 10.3% as prices remain elevated due to the wars in Iran and Ukraine.

In fact, European gas prices reached their highest level in more than 3 years on Wednesday. The continent's benchmark wholesale gas price, the front-month Dutch TTF contract, climbed above €80 a megawatt-hour on Wednesday, the highest since January 2023, after gaining almost 7%. And demand is expected to rise as winter approaches.