The European Central Bank (ECB) is poised to raise interest rates by 25 basis points to 2.50% at its September 10 meeting. This widely anticipated move is attributed to rising Harmonised Indices of Consumer Prices (HICP) inflation, which hit 3.3% in August, up from 2.9% in July, and the euro area's unexpected economic resilience despite geopolitical tensions. Nomura's Euro area team, among others, projects this increase, citing hawkish comments from ECB officials and the impact of the ongoing Iran war on energy prices. The first rate hike in three years occurred on June 11, lifting the deposit rate from 2% to 2.25%.
The primary driver of the current inflationary environment is surging energy costs, particularly Brent crude oil and Dutch TTF natural gas prices, exacerbated by the Middle East conflict and the closure of the Strait of Hormuz. ECB economists Kristina Barauskaitė Griškevičienė and Claus Brand noted that adverse energy supply factors accounted for approximately 90% of the increase in energy inflation between January and May 2026. This situation differs significantly from the 2021-2022 inflation surge, which was characterized by a combination of demand-side factors, supply chain disruptions, and the Russia-Ukraine war.
While headline inflation is rising due to energy, core inflation, which excludes volatile items like energy and food, declined to 2.4% in August from 2.5%, indicating that energy price increases have not yet broadly spilled over into underlying inflation. Economic growth in the euro area has been more resilient than expected, with Q2 GDP growing by 0.4% quarter-on-quarter, and August PMIs suggesting solid momentum continued into Q3. Manufacturing, especially in Germany, is showing a rebound, and unemployment remains low at 6.4% in July.
Beyond September, the trajectory of monetary policy largely hinges on the duration and severity of the Iran war. Nomura suggests that risks of further rate hikes, potentially in December, are significant if Brent crude oil prices remain high or Dutch TTF natural gas prices continue to rise. However, with the deposit rate at 2.50% after September, policy would be at the upper end of the ECB's estimated neutral range, and further hikes would move into restrictive territory. The combination of resilient growth and contained underlying inflation has led some analysts to revise their forecasts, suggesting the ECB may keep rates at 2.50% throughout 2027 rather than implementing cuts.
