The European Central Bank has raised interest rates for the first time since 2023, due to the conflict in Iran causing higher levels of inflation.
The benchmark deposit rate has risen from 2% to 2.25%, and follows the release of US inflation data yesterday which saw consumer prices rise by 4.2% in May, the highest annual rate in three years. Against a backdrop of geopolitical tensions, elevated energy prices and growing uncertainty over global monetary policy, policymakers now face an increasingly delicate balancing act between containing inflation and avoiding a deeper slowdown.
Industry experts have shared their immediate reactions to the rising rates below.
Salman Ahmed, Global Head of Macro and Strategic Asset Allocation, Fidelity International, said:
“The European Central Bank (ECB) hiked rates today as we expected, preferring to take a cautious stance as they face into this ongoing energy shock. What stood out in particular was the upgrade to core inflation forecasts – with 2026 now running above their prior adverse scenario, showing the clear inflationary nature of this shock and justifying their decision to hike at this meeting.
“Going forward we expect the ECB to hike again, with the July meeting now live, against the likely backdrop of higher for longer energy prices, as we do not expect any clean break solution to the US-Iran war, with commodities likely to carry a premium – with tail risks of even higher prices remaining a risk the longer the Strait of Hormuz remains closed and while the risk of further escalation remains in the background.
“The ECB’s outlook is, however, clouded by uncertainty and this is reflected in their use of scenario analysis, including both more severe and milder scenarios. They will remain attuned to both upside risks to inflation while trying to balance downside risks to growth even if there has been relative resilience in euro area growth to date.
“Other risks to the outlook stem from currency effects, particularly if the Fed begins to chart a more dovish course relative to market expectations and the euro appreciates leading to the ECB taking a less hawkish stance. There will also be sensitivity to further deteriorations in EU-China relations and any potential for tit-for-tat measures that may negatively impact the European economy.”
Konstantin Veit, Portfolio Manager at PIMCO, said:
“We do not see this as the start of an aggressive hiking campaign, but rather as a modest adjustment aimed at managing expectations.
“As of today, we would not foresee the ECB to hike more than what is currently priced into financial markets. A further hike would lift the ECB’s main policy rate to the upper bound of the range of its neutral rate estimates (1.75% – 2.5%), a move primarily aimed at influencing selling price and inflation expectations.
“The longer the war related disruption persists, the more the focus will shift to an increasingly weak growth trajectory. Euro area Q1 GDP has been softer than expected, and recent PMIs suggest another mild contraction in Q2.
“Contrary to 2022, the negative supply shock is not amplified by a positive demand shock, alleviating the need for an extended hiking cycle.”
Felix Feather, Economist at Aberdeen Investments, said:
“Short-end market rate expectations moved slightly higher on the ECB’s decision to hike the deposit rate from 2.0% to 2.25%. Punchy upward inflation forecasts were probably behind the move. But we read the ECB’s communication of the decision more dovishly. The emphasis on its statement on preserving optionality pushes against hawkish market expectations for two further hikes by the end of the year.
“In fact, in describing its new stance of policy as “well-positioned”, the ECB could be hinting that it is not preparing any further tightening at this time.
“President Christine Lagarde’s upcoming presser might clear up some of this uncertainty. But we find nothing in this statement to shake our prior conviction: we are sticking with our call for this hike to be a one-and-done affair. Though there is a clear risk of further hiking, especially if the Iran war re-escalates.”
Richard Carter, head of fixed interest research at Quilter Cheviot, said:
“The European Central Bank is the first major central bank out of the starting gate with a 0.25% rate hike. This move had long been priced in by markets, with policymakers’ recent hawkish rhetoric leaving little doubt about the direction of travel.
“Alongside the rate hike, the ECB has published its updated macroeconomic projections which show inflation climbing significantly higher than was previously expected. Forecasts for 2026 and 2027 have been revised sharply upwards to 3.0% and 2.3% respectively, from 2.3% and 2.2% previously, reinforcing the case for having a tighter policy stance for longer. Meanwhile, projections for economic growth have been revised down to 0.8% in 2026 and 1.2% in 2027 from 0.9% and 1.3% previously.
“Markets are already pricing in a further rate hike at the ECB’s September meeting, but whether that materialises will depend heavily on developments in the Middle East and whether and when a meaningful resolution can be achieved. If a resolution is not met soon, we can expect higher energy costs to persist and broader inflationary pressures to mount, meaning policymakers may be forced to act again.
“The attention will now shift to whether the other major central banks will follow the ECB’s lead, but for now that looks unlikely. The Federal Reserve is set to meet on Wednesday for its first rate decision under new Chair Kevin Warsh, and despite a hotter than expected inflation print this week, the expectation remains for rates to be held for now.
“However, a 0.25% hike is being priced in before the end of the year, with the potential for more in early 2027. This is the exact opposite of what Trump is wanting to see from Warsh, so we can expect substantial pressure coming from the White House in the months ahead. Meanwhile, the Bank of England is also expected to keep rates on hold when it meets next Thursday, and the upcoming GDP and inflation numbers will provide an important update on the health of the economy ahead of that decision.”
Nicolas Forest, CIO at Candriam, said:
“The ECB’s decision to raise interest rates for the first time in nearly three years looks more like a credibility move rather than the start of a new tightening cycle. The memory of 2022 still looms large. The ECB wants to avoid the criticism it faced when it was perceived as reacting too late. This hike sends a clear message: the central bank is determined not to repeat the mistake.
“The latest inflation figures justify the action. Headline inflation rose to 3.2% in April, while core inflation reached 2.5%, highlighting the euro area’s sensitivity to higher energy prices following the Iran conflict. As price stability is its mandate, Christine Lagarde argues that: “the public may find it difficult to understand a reaction function that does not react”.
“However, we do not believe this marks the beginning of an aggressive tightening phase. The economic backdrop remains too fragile for that. The energy shock is already weighing on activity across Europe, with first-quarter growth slowing in most countries. Wage growth is moderating and labour market conditions are gradually softening. In this environment, second-round inflation effects are likely to remain limited, reducing the need for a prolonged hiking cycle.
“Our base case is for just one additional rate hike this year. Should geopolitical tensions ease, oil prices could fall back towards USD 80 per barrel, helping to ease inflationary pressures. That said, uncertainty remains exceptionally high, leaving the ECB is therefore reluctant to commit to a predefined policy path.
“Bond markets are currently pricing in nearly three rate hikes this year, which seems excessive. In this context, German government bonds could offer attractive opportunities. Credit markets also remain remarkably resilient, with corporate bond issuance continuing to be well absorbed by investors. This resilience is further supported by increasingly attractive yield levels.
“European equity markets are unlikely to suffer significantly from this rate hike. Much of the damage from higher energy prices has already been reflected in valuations, while investor attention remains firmly focused on technology opportunities. At this stage European equities appear more exposed to geopolitical developments than to ECB policy decisions.”
Daniele Antonucci, Chief Investment Officer at Quintet Private Bank (parent of Brown Shipley) said:
“The ‘insurance’ rate hike of the European Central Bank was flagged well in advance. With inflation rising and possibly feeding through a wide range of categories beyond energy, a recalibration was widely expected by the market. A further adjustment is possible this year. But economic growth is still rather weak, consumer spending moderate at best and the labour market rather stagnant. High oil prices, sooner or later, are likely to exert a negative effect, but a series of rapid rate hikes as we’ve seen in 2022 appears rather unlikely at this stage.
“The comparison with that period is understandable, but the context today is different. At that time, economies were reopening rapidly, interest rates were historically low, and inflationary pressures were already building before the energy shock intensified them. Today, interest rates are already at restrictive or near-neutral levels in most developed economies. This gives central banks more flexibility, even if higher oil prices put upward pressure on inflation. A rise in oil prices does not automatically lead to a sharp tightening cycle. As long as higher inflation doesn’t become entrenched again, central bank policy responses could be more measured.
“We do expect the Fed and Bank of England to follow the European Central Bank and raise interest rates modestly this year. But this appears to be largely reflected in market expectations. For portfolios, the likelihood of a sudden and aggressive shift in rate expectations, which was a key driver of volatility in 2022, seems relatively contained. If there is a single theme we hear when we speak with investors, it is that outcomes are becoming more varied and less predictable. Inflation shocks, political developments and technological shifts can all influence markets, sometimes simultaneously.
“In this context, diversification is not simply a defensive concept. It is a way of exposing portfolios to a range of potential drivers of return, while also including assets that may behave differently when conditions change. Within equities, this is reflected in how we position across regions and sectors. In the US, we continue to hold our equal-weighted index to diversify from the concentrated AI trade.
“European equities have lagged a bit this year, given their higher sensitivity to energy prices. However, we don’t want to reduce our current neutral allocation yet, as a potential end to the conflict might trigger a tactical rebound.”
Samuel Fuller, Director at Financial Markets Online, said:
“Yes the milestone matters, but the forecasts matter more. The ECB has become the first major central bank to raise interest rates to counter the inflationary shockwave triggered by the Iran War.
“That much was expected. What was more surprising was the sharp downturn in the ECB’s forecasts. It now predicts slower growth across the Eurozone both this year and next, and forecasts that headline inflation will hover at 3% in 2026, a big jump from its previous forecast of 2.6%.
“The grim inflationary outlook has amplified speculation about whether today’s rate rise will be a one-off or one of many. As recently as last week, optimists were still confidently asserting that any June rate hike would be a ‘one and done’ affair. Now no-one can be sure, after the Bank left open the door to further rate rises if inflation fails to abate.
“European equities are sliding in response as markets price in at least one more rate hike before the year is out. But this is far from a simple bet. Even though the Bank’s forecasts scotch hopes that the inflationary shock might be fleeting, slowing growth will make it wary of overtightening the monetary screw.
“The Euro has barely flickered – when ordinarily the prospect of higher interest rates would send it up – but this may be a case of monetary policy taking a back seat as missiles once again fly in the Gulf. For Britain, the ECB’s decision is a precedent. When the Bank of England meets to set its base rate next week, there’s an increasing likelihood that it will follow Frankfurt’s lead.”
Stefan Gerlach, Chief Economist at EFG Bank, said:
“The ECB raised rates by 25 basis points to 2.25%. This follows the rise in inflation from 1.9% in February to 3.2% in May caused by the start of hostilities in the Persian Gulf. The rate hike should be seen as an insurance move to reinforce the ECB’s inflation fighting credibility, not as the beginning of an aggressive tightening cycle.
“Today’s situation differs markedly from 2022. Underlying inflation pressures are contained: core inflation rose only from 2.4% in February to 2.5% in May. Policy rates are already restrictive, and wage growth, fiscal support and household balance sheets are all weaker.
“Nevertheless, higher energy prices are likely to feed through to the wider economy, although the extent and the speed by which they do so remain highly uncertain.
“Future rate decisions will therefore depend on whether higher energy costs trigger second round effects through wages and services prices, for which there is currently little evidence.”
Chris Beauchamp, Chief Markets Analyst at investing and trading platform IG, said:
The ECB’s rate increase was a foregone conclusion, and to be fair to the bank this isn’t the kind of policy mistake that saw them raise rates in the teeth of a credit problem or a sovereign debt crisis. But it needs to avoid the temptation to repeat 2022’s moves, since the outlook now is very different. Investors will hope that the bank doesn’t become too trigger happy, and that a saner approach prevails from here.”
