ECB Raises Key Interest Rates by 25 Basis Points, Citing Middle East War and Energy Prices

In updated baseline projections, Eurosystem staff now expect headline inflation to average 3.0% in 2026, 2.3% in 2027 and 2.0% in 2028. Compared with the March projections, the 2026 and 2027 figures have been revised upward, primarily because of a higher assumed path for energy prices, which the ECB said would feed through to food, goods and services inflation. Euro area energy price inflation stood at 10.9% in May, up from 10.8% in April.

Inflation Outlook Revised Up

Underlying price pressures have also strengthened. Inflation excluding energy and food rose to 2.5% in May from 2.2% in April, with goods inflation edging up to 0.9% and services inflation climbing from 3.0% to 3.5%. The ECB said it expects the increase in energy prices to lift inflation further over the summer and keep it well above the 2% target into the first half of 2027.

Lagarde Links Decision to Middle East War

Lagarde, asked about the rationale for the move, said: 'The war in the Middle East is generating inflation pressures, and the decision to raise rates is robust across a range of scenarios mapping out how the shock might evolve and affect the medium-term outlook for the euro area.' She added: 'We are not pre-committing to a particular rate path.' The Governing Council echoed that message, stating: 'With today's decision, the Governing Council remains well positioned to navigate the uncertainty caused by the war.'

Growth Projections Cut

Growth has been marked down. The baseline now sees euro area economic growth averaging 0.8% in 2026, 1.2% in 2027 and 1.5% in 2028, a downward revision for 2026 and 2027 that the ECB attributed to a more pronounced impact of the war on commodity markets, real incomes and confidence. Risks to the growth outlook, the Council said, remain tilted to the downside, mainly because of the conflict in the Middle East. Euro area unemployment stood at 6.3% in April 2026.

Manufacturing has so far held up, partly because firms have been building up stocks to cope with supply-chain pressures and partly because of higher defence spending. The ECB's wage tracker and surveys on wage expectations continue to indicate that wage growth should ease over the course of the year, a development the Council is watching closely as it considers the durability of the inflation shock.

Fiscal and Strategic Priorities

The Council said its future interest-rate decisions will be based on its assessment of the inflation outlook and the risks surrounding it, in light of incoming economic and financial data, the dynamics of underlying inflation, and the strength of monetary policy transmission. The updated illustrative scenarios accompanying the staff projections will be published on the ECB's website. The medium-term inflation target remains 2%, and the Council stated it stands ready to adjust all of its instruments within its mandate to ensure inflation stabilises at that level.

On fiscal policy, the Governing Council said that responses to the energy price shock should be temporary, targeted and tailored, in line with the European Commission's 2026 European Semester Spring Package. It also reiterated that the digital euro and tokenised wholesale central bank money will enhance Europe's strategic autonomy, competitiveness and financial integration.