ECB lifts rates as energy inflation returns

The European Central Bank has raised its three key interest rates by 25 basis points as higher energy costs push inflation further above target and add another layer of pressure to borrowing conditions across the euro area.

The decision takes the deposit facility rate to 2.50%, the main refinancing operations rate to 2.65%, and the marginal lending facility rate to 2.90%, with the changes taking effect from 16 September.

The ECB said the conflict in the Middle East continues to generate inflationary pressure, with headline inflation now expected to average 3.0% in 2026, 2.5% in 2027, and 2.1% in 2028. Its projection for inflation excluding energy and food stands at 2.5% this year, 2.6% next year, and 2.3% in 2028.

The forecasts leave inflation above the central bank’s 2% medium-term target for an extended period, while showing greater resilience in economic activity than policymakers had expected earlier in the year.

Growth is forecast at 0.9% in 2026, 1.4% in 2027, and 1.5% in 2028. The projections for 2026 and 2027 have both been revised upwards, reflecting stronger-than-expected performance across the euro-area economy.

The Governing Council said it was “not pre-committing to a particular rate path”, retaining the meeting-by-meeting approach that has shaped monetary policy through successive economic shocks.

The immediate pressure is coming from energy. Euro-area inflation rose to 3.3% in August from 2.9% in July, while energy price inflation increased to 14.3% from 10.3%. Higher commodity prices and refining margins have contributed to the increase.

Underlying price pressures have been more contained. Inflation excluding energy and food eased to 2.4% in August from 2.5% a month earlier, while wage growth has also moderated. Compensation per employee grew at an annual rate of 3.3% in the second quarter, compared with 3.5% in the first.

The divergence leaves policymakers balancing an externally driven energy shock against an economy that has so far absorbed higher costs without a severe deterioration in activity. Manufacturing has remained comparatively resilient, supported by public spending on defence and infrastructure, while digital investment continues to contribute to services and capital expenditure.

Financial conditions have already tightened. Bank lending rates for companies increased to 3.8% in June and July, from 3.6% in May, while the cost of market-based corporate debt stood at 4.0% in July. Borrowing costs are therefore moving higher before the latest rate increase is fully transmitted through the economy.

Companies with refinancing requirements, capital-intensive investment programmes, or floating-rate borrowing now face a higher hurdle for investment at a point when energy and geopolitical risks are already complicating planning.

Large financing requirements associated with infrastructure, defence, energy, and technology investment are also adding to demand for capital across Europe. Higher sovereign yields can tighten conditions independently of central-bank action by lifting the cost of debt throughout the economy.

The policy shift comes against a different backdrop from the inflation surge earlier in the decade. Labour markets remain relatively firm, with euro-area unemployment at 6.4% in July, while productivity has improved and unit labour-cost growth has slowed.

That gives the ECB more room to distinguish between temporary imported inflation and evidence that higher prices are becoming embedded domestically. Persistent energy costs could still feed into transport, manufacturing, and services prices, particularly where companies cannot absorb the increase through margins.

The ECB has identified further disruption to energy supplies, renewed trade tensions, tighter financial markets, critical raw-material shortages, and adverse weather as risks to its central projections. A faster adaptation by energy markets or a sustained easing of geopolitical tensions could produce a less inflationary outcome.

The new rates take effect on 16 September. Beyond that date, future decisions will depend on incoming inflation data, underlying price pressure, and the strength with which tighter monetary policy is transmitted through lending and capital markets.