The ECB is caught between two bad options
For the first time in nearly three years, the European Central Bank is poised to raise borrowing costs — a quiet but consequential act that reveals how distant conflicts reshape the daily economics of ordinary life. The war involving Iran and the near-closure of the Strait of Hormuz have sent energy prices surging across nineteen nations that share a currency, pushing eurozone inflation to 3.2 percent and forcing the hand of an institution that had only recently finished cutting rates. The ECB's expected quarter-point hike on Thursday is less a confident assertion of strength than a careful reckoning with an old dilemma: how to cool prices without extinguishing what little growth remains.
- Energy prices unleashed by the Iran conflict have driven eurozone inflation to 3.2%, well above the ECB's 2% target and triggering the bank's first rate hike since September 2023.
- The eurozone economy is already fragile — growth forecasts have been slashed to 0.9% for 2026, and first-quarter GDP actually shrank by 0.2%, raising fears that tighter credit could deepen the slowdown.
- ECB officials, including chief economist Philip Lane, have been openly signaling the hike for weeks, while the Federal Reserve and Bank of England have chosen to hold steady and wait out the conflict.
- Critics argue the move is premature, with Allianz's chief economist calling it unnecessary given the visible growth slowdown — but the ECB remains haunted by its slow response to the 2022 inflation surge.
- Markets and investors will hang on every word from ECB President Christine Lagarde's Thursday press conference, searching for signals on whether further hikes are coming or whether this tightening cycle will be brief.
The European Central Bank is set to raise interest rates on Thursday for the first time in two and a half years — a decision driven not by domestic missteps but by the distant tremors of war. The conflict involving the United States, Israel, and Iran has effectively choked the Strait of Hormuz, sending energy prices surging across the eurozone and pushing inflation to 3.2 percent in May, above the ECB's 2 percent target. Economists are nearly unanimous: a quarter-point increase to the deposit rate, bringing it to 2.25 percent, is all but certain.
The move marks a sharp reversal. After battling the inflation wave triggered by Russia's invasion of Ukraine, the ECB had spent the better part of two years cutting rates and then holding them steady. Now, with energy shocks rippling through households and supply chains once again, the bank is pivoting back toward tightening. Chief economist Philip Lane signaled as much in late May, noting that inflation forecasts would likely be revised upward and that the Iran war had darkened the economic outlook.
Not everyone is convinced the timing is right. The eurozone is already under strain — the EU cut its 2026 growth forecast to just 0.9 percent, and revised data confirmed the economy contracted in the first quarter. Allianz's chief economist called the hike unnecessary, arguing the ECB could afford to wait given the clear slowdown in growth. But the bank appears unwilling to repeat the criticism it faced in 2022 for moving too slowly.
What follows Thursday's decision may matter more than the decision itself. Most analysts expect at most one additional hike in July before the tightening cycle ends — the economic backdrop is weaker than in 2022, and the inflation pressure from energy prices is expected to moderate. For now, the ECB has chosen the harder path: accepting the risk of slower growth in order to keep inflation from drifting further out of reach.
The European Central Bank is about to do something it hasn't done in two and a half years: raise interest rates. The decision comes Thursday, and economists are nearly unanimous that it will happen. The culprit is not a surprise—it's the same thing that has upended markets and supply chains across the globe. The war between the United States and Israel against Iran, and the near-total closure of the Strait of Hormuz, has sent energy prices soaring. In the eurozone, where nineteen countries share the euro, inflation accelerated to 3.2 percent in May. That's above the ECB's target of 2 percent, and it's enough to force the central bank's hand.
For months, the ECB had kept borrowing costs steady. Inflation in the eurozone had been manageable, under control. But energy shocks have a way of rippling through an entire economy. When oil and gas become scarce and expensive, everything else follows. Households pay more to heat their homes. Businesses pay more to move goods. Prices rise. The ECB's governing council is expected to increase the key deposit rate by a quarter percentage point, moving it from 2.00 to 2.25 percent. "Anything but a rate hike at the ECB meeting would be a big surprise," said Carsten Brzeski, an economist at ING. The logic is straightforward: higher borrowing costs dampen demand, which helps bring inflation back down. The Federal Reserve and the Bank of England, by contrast, have held their rates steady as they wait to see how the conflict plays out.
The last time the ECB raised rates was September 2023, when it was fighting a historic surge in inflation triggered by Russia's invasion of Ukraine. After that wave subsided, the central bank cut rates repeatedly, then held them flat starting in June of last year. Now, with energy prices spiking again, it's moving in the opposite direction. Several ECB officials have been preparing the ground publicly. Philip Lane, the chief economist, signaled in late May that a hike was coming. He told a Japanese business publication that the ECB's inflation forecasts would likely be revised upward at Thursday's meeting, and that several factors tied to the Iran war had darkened the macroeconomic outlook.
But not everyone thinks this is the right move. Some economists argue that raising rates now could strangle growth in an already sluggish eurozone. The region is heavily dependent on energy imports, and the war is already a headwind. Last month, the European Union cut its growth forecast for the eurozone to 0.9 percent for 2026, down from 1.2 percent. Revised data released Friday showed the eurozone economy actually contracted by 0.2 percent in the first quarter. Ludovic Subran, chief economist at Allianz, told AFP that the rate hike would mainly serve to "provide reassurance" that the ECB was paying attention to inflation. But he added: "This hike is not necessary; the ECB could wait, especially since the slowdown in growth is clear." The central bank, however, may be wary of waiting too long. It faced criticism in 2022 for moving too slowly to contain the inflation surge, and that memory lingers.
What happens next is the real question. Christine Lagarde, the ECB president, will hold a press conference after the rate decision Thursday, and investors will scrutinize every word for hints about what comes next. Most analysts don't expect this to be the start of an aggressive rate-hiking cycle. The economic backdrop now is different from 2022, when inflation was already elevated before Ukraine, and the global economy was tangled in post-pandemic supply chain problems. Jack Allen-Reynolds, deputy chief eurozone economist at Capital Economics, expects another hike in July, but thinks the tightening will stop there. The impact of higher energy prices on inflation should be limited, he said, meaning the ECB's rate-hiking campaign will be brief. For now, the central bank is caught between two bad options: raise rates and risk slowing growth further, or hold steady and risk letting inflation drift higher. Thursday's decision suggests it has chosen the former.
Citações Notáveis
Anything but a rate hike at the ECB meeting would be a big surprise— Carsten Brzeski, ING economist
This hike is not necessary; the ECB could wait, especially since the slowdown in growth is clear— Ludovic Subran, Allianz chief economist
A Conversa do Hearth Outra perspectiva sobre a história
Why is the ECB moving now, when growth is already so weak?
Because inflation is above target, and central banks are supposed to care about that. But you're right—it's a bind. The energy shock is real, and prices are rising. If they don't act, they look asleep at the wheel again.
Is this going to be a long campaign of rate hikes?
No. Most analysts think one or two moves, then they stop. The energy price shock should fade. This isn't like 2022, when inflation was baked into the whole system.
What's the real risk here?
That they slow growth too much in a region that's already struggling. The eurozone is dependent on energy imports, and the war is already hurting. Raising rates makes borrowing more expensive for everyone.
Could they have waited?
Probably. Some economists think they should have. But the ECB got burned before for moving too slowly. They're trying not to repeat that mistake.
What will Lagarde say that matters?
Anything about the path forward. Will there be another hike in July? Will they pause after that? The market is listening for signals about how long this cycle lasts.