The European Central Bank has raised interest rates for the first time in nearly three years, responding to rising inflation driven largely by higher energy prices linked to the ongoing conflict involving Iran.
The ECB increased its key interest rate for the eurozone by 0.25 percentage points, bringing it to 2.25%. This makes it the first major central bank to raise borrowing costs since the outbreak of the latest Middle East conflict on February 28.
According to the ECB, the war in the Middle East is creating new inflationary pressures. The bank warned that the economic outlook remains uncertain, with increasing risks to inflation and downside risks to economic growth.
Inflation across the 21 countries using the euro rose to 3.2% in May, up from 3.0% in April, mainly due to higher energy costs. Like most major central banks, the ECB aims to maintain inflation at around 2%.
Europe remains heavily dependent on imported fossil fuels to power its economy. As a result, the conflict has significantly increased energy import costs, forcing European countries to spend billions more on energy supplies. These rising costs threaten to slow the region’s fragile economic recovery, which only recently emerged from the energy crisis triggered by Russia’s invasion of Ukraine in 2022.
Eurozone inflation previously peaked at 10.6% in October 2022, while ECB interest rates reached a record 4% in September 2023 following an aggressive campaign of rate hikes aimed at curbing soaring prices.
Meanwhile, the International Monetary Fund forecasts eurozone economic growth of 1.1% in 2026, according to its April assessment. This represents a downward revision of 0.2 percentage points compared to its January forecast.
