The European Central Bank raised interest rates on Thursday, becoming the first major central bank to act to rein in rising inflation set off by the war in the Middle East.
Policymakers, who set rates for the 21 countries that use the euro, lifted their key rate by a quarter of a point, to 2.25 percent. It was the central bank’s first increase since September 2023. Officials cut rates eight times in 2024 and 2025.
Thursday’s move was an effort to counter the economic fallout of the war, which has closed the Strait of Hormuz, a critical waterway for energy and other commodities off Iran’s southern coast, for more than three months. In May, the inflation rate in the eurozone was 3.2 percent, driven by higher energy prices and well above the central bank’s target of 2 percent. Before the war, the inflation rate was just below 2 percent.
“The war in the Middle East is generating inflation pressures,” officials said in a statement, as the bank raised its projections for how much prices will increase this year and next. It also lowered its forecasts for economic growth.
Higher prices for energy, fertilizer and other goods that are exported from the Persian Gulf through the strait are pushing up inflation worldwide. Those rising costs are weighing on economic growth, leaving central bankers to balance the risks of higher inflation against those of a slowdown.
So far central banks in several other countries, including South Africa, Australia and Norway, have raised rates since the war began in late February. The Bank of Japan is expected to raise rates next week for the first time since December.
In the United States, where prices are rising at their fastest pace in three years, the Federal Reserve will meet next week. The Fed was not expected to change rates, but there are growing bets among investors that it will increase rates later in the year.
For the past year, the E.C.B. has held rates at 2 percent, a level intended to neither bolster nor restrict the economy. While Europe has been grappling with how to improve competitiveness and generate sustained growth, policymakers expected that keeping rates low would, in the short term, support the economy through more consumer spending and businesses investment.
Instead, the conflict in the Middle East quickly upended those expectations. Soaring energy prices added uncertainty and unpredictability. Economists, weighing a range of increasingly adverse scenarios, have started to predict sharply higher inflation, slower economic growth and even recession.
E.C.B. officials said that Thursday’s decision to raise rates was “robust” in light of a range of scenarios it considered aiming to predict how the war might affect the European economy in the next few years.
Staff at the bank said that, in their main scenario, inflation would be higher than they projected nearer the outset of the conflict. Inflation would average 3 percent this year and 2.3 percent next year, returning to target in 2028. They expected higher energy prices to partially feed into higher prices for food, other goods and services. They lowered their economic growth forecasts, projecting the region’s economy to grow just 0.8 percent this year, because of a “a more pronounced impact of the war on commodity markets, real incomes and confidence.”
“The outlook remains uncertain, with upside risks for inflation and downside risks for economic growth,” the bank said.
Still, the eurozone economy has not shown signs of a repeat of 2022, when Russia invaded Ukraine. Europe responded by cutting itself off from Russian gas, a critical energy supply, and inflation climbed into the double digits. So far, traders aren’t betting that it’s the beginning of a long and aggressive cycle of rate increases. But they will be closely watching a news conference on Thursday by Christine Lagarde, the E.C.B. president, for hints of what the central bank will do in the months ahead. Ahead of the meeting, traders were betting that by next spring rates would be three-quarters of a percentage point higher than they are now.
The E.C.B. is weighing higher inflation against signs of any economic slowdown caused by the war. Consumer confidence has plummeted and could weigh further on spending, while businesses and governments are diverting money to pay the higher costs of energy. The central bank is expected to lower its growth forecasts for this year and next.
To some extent, slower growth could mitigate the pressure of higher prices. If consumers grow more nervous about spending, companies may find it harder to raise prices. At the same time, workers may not be able to push for higher wages if the labor market weakens. That could stop inflation from rising as quickly or for as long.
The prospect of a deeper slowdown has made some economists concerned that rate increases could be a mistake. They have raised comparisons to 2011, when the E.C.B., led by Jean-Claude Trichet, raised rates twice in the first half of the year only to have Mario Draghi, Mr. Trichet’s successor, cut rates a few months later.
Frederik Ducrozet, head of strategy and macro research at Pictet Wealth Management, said he did not believe it was necessary for the E.C.B. to raise interest rates because he didn’t see any signs of so-called second round effects, in which higher energy costs lead to higher wages.
The bigger issue, he said, is how officials communicate what will happen next.
How hawkish will they be “into a stagnating, if not contracting, economy?” he added. “That worries me more than this week’s move.”
The post Europe Raises Interest Rates as War Stokes Inflation appeared first on New York Times.
