ECB Holds Rates Steady as Iran-Linked Energy Shock Threatens Inflation Outlook

The European Central Bank voted unanimously on Thursday to keep its main interest rate unchanged at 2.25%, a move that fell in line with market expectations but did little to dispel bets on a rate increase in September.

The bank’s deposit rate remains at 2.25%, with the main refinancing rate at 2.40% and the marginal lending rate at 2.65%. The decision follows a quarter-point hike in June — the ECB’s first since 2023 — as inflationary pressures from the Iran-linked energy shock began to weigh on Europe’s economy.

Eurozone inflation eased to 2.8% in June from 3.2% in May, but the ECB said it still expects price growth to remain “well above target” until the first half of 2027. The bank targets an inflation rate of 2%.

**Energy Shock Dominates Outlook**

The hold was widely anticipated after a string of benign data on prices, wages and economic activity, but the recent resurgence of conflict in the Middle East has upended earlier assumptions that energy costs would moderate quickly.

Brent crude oil has returned to $100 a barrel following the resumption of hostilities, and natural gas prices have surged to more than three-year highs, according to reports. The ECB assessed that energy prices remain volatile and consistently elevated compared to pre-war conditions.

“Renewed disruption of energy supplies could increase energy prices further and for longer than expected,” ECB President Christine Lagarde told a news conference Thursday. “The longer energy prices stay high, the more likely they are to drive up broader inflation through indirect and second-round effects.”

The bank’s statement noted that “uncertainty remains high and the full inflationary impact of the energy shock has yet to play out,” adding that it is “closely monitoring the intensity and duration of the shock, as well as its indirect and second-round effects.”

**September Hike in Play**

The decision to hold was unanimous, but Lagarde acknowledged that some governors had raised the question of a rate increase at this month’s meeting. “There were some governors who asked themselves whether we should not consider a hike; in other words, raising the three interest rates,” she said.

The ECB had previously flagged a hold on the premise that energy prices were falling and moving closer to the mildest of three scenarios it set out in March. That scenario “looks quite unlikely, let’s face it,” Lagarde said.

“Lagarde’s comments at the press conference clearly point to a September rate hike,” said ING economist Carsten Brzeski. “The European Central Bank has again turned more hawkish, suggesting that a September rate hike is almost a done deal.”

Traders now expect a 0.25% hike in September, according to Ed Hutchings, head of developed market rates at Aviva Investors. “Inflation expectations remain elevated and if sustained further, even tighter policy may well be needed,” Hutchings said.

Investors have priced in almost three more interest rate increases over the coming year, with a first move fully priced in by October and a second by February, according to market data. However, most economists surveyed by Reuters say the 21-country eurozone will need far less tightening to contain inflation hovering around 3%.

“Despite its ability to hold rates today, the market still expects the ECB to be in a rate raising mood for the rest of the year,” said Richard Carter, head of fixed interest research at Quilter Cheviot. “Clearly how aggressive it is in upping interest rates depends broadly on what is happening away from the continent, and that is making the job of the policy committee incredibly challenging.”

**No Second-Round Effects Yet — For Now**

A key factor in the ECB’s decision to hold was that long-feared second-round effects from the energy price spike have yet to materialize. “We are not seeing a second-round effect,” Lagarde said. Firms surveyed by the bank did not point to such impacts in their pricing or pay decisions, and wage growth is continuing to slow as the ECB has forecast.

“None of those elements for the moment … are giving us second-round effects indications,” she said.

The labor market remains relatively soft, particularly in Germany, the bloc’s largest economy, while surveys indicate muted pay pressures. Consumers have dialed back their price expectations, and services inflation actually slowed last month.

Trade tensions, high energy costs and China’s expansion into some of Europe’s key export markets suggest that the bloc’s industries will continue to struggle, putting downward pressure on labor demand.

**Additional Risks**

Lagarde also flagged a potential risk from scorching summer weather across much of Europe. The heat may have damaged crops, pushing up food prices, while low water levels on key rivers could create shipping bottlenecks.

The ECB and its counterparts are weighing the timing of future moves. The U.S. Federal Reserve and the Bank of England both make rate decisions next week.

Asked about persistent rumors that she might leave the ECB early, Lagarde said she was not about to depart but did not say she would stay until her term expires in late 2027. “You are not going to see the back of me before 2027,” she said.