Frankfurt has tightened again.
The European Central Bank’s governing council lifted the deposit facility rate from 2.25% to 2.5% on Thursday. It is the second hike since 11 June, when the ECB moved for the first time in three years.
The ECB sets monetary policy for the eurozone through three key interest rates, with the deposit facility rate serving as its main policy benchmark.
The main refinancing rate was lifted to 2.65% and the marginal lending facility to 2.9%.
In its statement, the central bank noted that “the conflict in the Middle East continues to generate inflation pressures, and inflation is set to remain well above target for an extended period,” while ensuring that “with today’s decision, the Governing Council remains well positioned to navigate the uncertainty caused by the conflict.”
The ECB staff projections continue to estimate that headline inflation will average 3% this year. However, it has revised up the expectations for 2027 and 2028 to 2.5% and 2.1% respectively, compared with June.
An energy problem, not a demand problem
The decision follows an August inflation reading of 3.3%, up from 2.9% in July and the highest since September 2023.
Energy costs did nearly all the work, with energy inflation jumping to 14.3% from 10.3%, as fighting around the Strait of Hormuz kept crude supply constrained. The problem persists as Brent crude crossed $100 a barrel again on Wednesday due to renewed exchanges of fire between the US and Iran.
Underneath, the picture is calmer.
Core inflation, which strips out energy, food, alcohol and tobacco, actually fell to 2.4% from 2.5% in August, while services inflation, the component most sensitive to wages, dropped to 3% from 3.3%. There is still little sign that expensive energy is spreading into the rest of the economy.
That distinction has been central to the ECB’s own thinking.
In a paper published earlier this month, its economists found that adverse energy supply factors accounted for around 90% of the rise in energy inflation between January and May of this year.
“This time the energy supply shock dominates, while demand and public policy stimulus have minor roles,” the economists wrote, contrasting it with the 2021-22 surge that prompted a far more aggressive response.
A single rate for very different economies
The eurozone inflation average conceals a wide spread.
August inflation ran at 4.5% in Spain, 2.9% in Germany and 2.7% in France, three economies facing the same energy shock with markedly different outcomes.
Growth complicates matters further.
The bloc has held up better than expected, but resilience is not overheating, and even at 2.5% the deposit rate remains within the range the ECB considers neutral. Going further would mean deciding that policy must actively restrain the economy.
Christine Lagarde had signalled this move in July, when the council held rates but instructed staff to model oil and gas scenarios ahead of September.
“The burden of proof is on data,” Lagarde said then, adding that “the full inflationary impact of the energy shock has yet to play out.”
Thursday’s decision comes alongside fresh staff projections, though their cut-off date falls roughly two weeks before the meeting, meaning neither the latest leg higher in oil nor the surge in European government bond yields to 15-year highs will be reflected.
Attention now turns to Frankfurt’s peers.
The Federal Reserve will announce on 16 September and the Bank of Japan on the 18, with both expected to consider hikes of their own.
Meanwhile, the Bank of England will decide on 17 September and is expected to hold rates as it currently maintains a much higher benchmark than the rest at 3.75%.
