The European Central Bank (ECB) increased its interest rates to 2.5% on Thursday, September 10, 2026, marking the second hike since the Iran war began. This decision comes as inflation remains well above target and the euro area's economy shows surprising resilience. All but one analyst in a Bloomberg poll had anticipated a quarter-point increase in the deposit rate.
The ECB's new quarterly forecasts are expected to bolster the case for further action by indicating stronger inflationary pressures alongside faster economic growth within the 21-nation euro area. This hawkish stance by the central bank, driven by concerns over the Iran war fueling inflation, has led to a selloff in government bonds across Europe. For example, Germany's bond yield approached 3.5%.
The ECB warned that the risk of higher inflation over the coming year has risen following renewed fighting in the Middle East, specifically after recent US and Iran attacks on ships in the Strait of Hormuz. This geopolitical tension also caused oil prices to top $105 a barrel and gas prices to jump, contributing to the surge in European borrowing costs and UK government debt rising to a 19-year high.
While investors had largely expected the ECB to raise borrowing costs, the central bank's hawkish tone in its report, which highlighted building inflationary pressures across various sectors, spooked markets. The ECB's President Christine Lagarde noted resilient growth and robust labor markets, but also acknowledged that headline inflation is projected to remain above target through the first half of 2027, with risks to the growth outlook remaining on the downside due to ongoing conflicts and potential energy disruptions.
Investors are now betting on additional rate increases, with Tradeweb data showing expectations for the ECB's deposit rate to end the year at 2.75%, implying another quarter-point hike. Before Thursday's decision, derivatives pricing had indicated a year-end rate of 2.68%.
