ECB raises interest rates as Iran war fuels inflation fears

The European Central Bank (ECB) increased interest rates on Thursday (Sep 10) for the second time in 2026, aiming to curb an inflation surge driven by the Iran war. Since late August, attacks from both sides have disrupted a month of relative peace, with the US and Iran targeting military, shipping, and energy assets. This has pushed oil prices back above $100 per barrel and rekindled fears of price hikes in fuel-importing countries across the eurozone.

The ECB raised its policy rate to 2.50 percent from 2.25 percent, stating that inflation is projected to remain well above its 2 percent target for an extended period. The central bank also revised its growth and inflation projections, acknowledging the economy's stronger-than-expected performance and the impact of higher fuel costs on other prices. Inflation is now forecast at 3.0 percent this year, 2.5 percent in 2027, and 2.1 percent in 2028.

Financial markets anticipate one more rate hike this year, followed by additional increases next year. Economists, however, believe that Thursday's action may be the ECB's final move for now, though some analysts see a risk of further tightening. ECB President Christine Lagarde is expected to maintain a cautious approach during her post-decision press conference, leaving the door open to further tightening based on incoming data.

The eurozone economy has been performing better than expected, despite higher fuel costs and competition from China. Bank lending accelerated in July, indicating that the June rate hike did not dampen activity, which could justify additional tightening by the ECB. However, policymakers will monitor rising government borrowing costs, which have reached levels not seen since before the global financial crisis, fueled by inflation concerns and concerns about mounting government debt.

Competition from bond sales by tech companies raising money for the AI boom has also contributed to higher yields, while political instability in Germany has added pressure to German government bonds, the benchmark for the eurozone. So far, economic indicators have been relatively stable. Core inflation, excluding energy and food prices, declined to 2.4 percent last month, while consumer expectations for price growth have softened. Pay raises have also moderated.

Lagarde's tenure as ECB president, set to end on Oct 31, 2027, will likely be a focal point during the press conference. She has been linked to the leadership of the World Economic Forum and has expressed interest in championing European values during the upcoming French presidential election. A rumor about a potential board member, Isabel Schnabel, joining the International Monetary Fund could lead to a reshuffle at the ECB's leadership.