The European Central Bank kept its key interest rate unchanged on Thursday, opting to wait for additional data before determining whether price pressures stemming from the Iran conflict necessitate further policy tightening.
The deposit facility rate was held at 2.25%, a decision that aligned with the expectations of both economists and investors. Market participants anticipate the ECB will follow its June rate hike with another 25-basis-point increase in September.
The ECB reiterated that it will not pre-commit to a specific policy path, instead making decisions on a meeting-by-meeting basis, guided by incoming data.
"Uncertainty remains elevated, and the full impact of the energy shock on inflation has not yet been fully realised," the institution stated in a release. "The Governing Council is therefore closely monitoring the intensity and duration of this shock, as well as its indirect effects and second-round impacts."
Policymakers reaffirmed that the ECB is "well-positioned" to manage the current situation.
Following the announcement, bond prices saw little change, with the yield on the 10-year German Bund rising 2 basis points to 3.19%. Earlier in the session, the yield had touched 3.21%, its highest level since 2011, as surging oil and gas prices amplified inflation concerns.
Market bets on the future direction of interest rates also remained steady. Swap pricing indicates that a 25-basis-point rate hike in September is nearly fully priced in, and a further increase before the end of the year is also considered highly probable. The euro continued its decline, falling 0.2% against the US dollar to trade around $1.1390.
The ECB's hawkish stance keeps it at the forefront of central banks within the Group of Seven. Last month, it became the first G7 central bank to raise interest rates since the outbreak of the Iran war.
At that time, the ECB warned that war-induced inflation was no longer confined to the energy sector but was spreading more broadly, while the economy remained resilient. Policymakers are now weighing whether further tightening measures are necessary.
The September meeting is widely viewed as the natural moment for a potential rate increase if warranted. This session will be supported by new quarterly staff forecasts, two months of inflation data, and a wealth of other economic indicators, including business surveys.
Although some officials had earlier in July believed that Middle East peace efforts might limit the war's impact on eurozone consumer prices, the renewed escalation of the conflict has revived such concerns.
Energy prices have risen sharply. Brent crude oil is approaching $100 per barrel after Iran-backed Houthi rebels claimed responsibility for attacking two Saudi oil tankers in the Red Sea, raising the risk of further supply disruptions. This could exert renewed upward pressure on inflation, which had slowed to 2.8% in June.
When the conflict reignited earlier in July, Yannis Stournaras, one of the most dovish members of the ECB's Governing Council and Governor of the Bank of Greece, acknowledged, "We are back to square one." His hawkish German counterpart, Bundesbank President Joachim Nagel, emphasised that the ECB would maintain a "vigilant stance."
The June staff baseline forecast projected inflation at 3% for this year, before slowing to 2.3% in 2027 and 2% in 2028. However, core price growth, which excludes energy and food, is expected to remain above the ECB's 2% target through 2028.
Following last month's rate hike, a debate has emerged over whether the ECB might repeat the mistakes of 2008 and 2011, when it raised rates only to reverse course shortly after. This discussion continues, particularly after a sharp drop in energy prices fuelled by peace talks between Washington and Tehran.
When raising rates in June, officials analysed the experience of the 2011 rate hike, concluding that this time they must avoid pre-committing to further tightening.
Nevertheless, despite their earlier nervousness, the recent escalation of the war has bolstered policymakers' confidence that the latest rate hike was entirely justified.
The widening scope of the conflict has once again heightened the possibility of a prolonged blockage of the Strait of Hormuz, restricting energy supplies and potentially driving prices even higher.
Neither US President Donald Trump nor Iranian officials have signalled that peace negotiations might resume in the near future.
Comments