ECB Hikes, Sees Higher Inflation, Lower Growth as Middle East Conflict Deepens

The European Central Bank raised its key interest rates by 25bps as widely expected, and the accompanying statement delivered a clear message: the Middle East conflict is now a major inflation problem for the Eurozone. Explaining the decision, ECB said that “the war in the Middle East is generating inflation pressures” and that the rate increase was “robust across a range of scenarios” describing how the shock could evolve. The deposit rate was raised to 2.25%, while the main refinancing rate increased to 2.40%.

The ECB also raised its inflation outlook higher. Under the new staff projections, headline inflation is expected to average 3.0% in 2026, 2.3% in 2027 and 2.0% in 2028. Core inflation is projected at 2.5% in both 2026 and 2027 before easing to 2.2% in 2028.

Policymakers explicitly attributed the upward revisions to higher energy prices and warned that these costs are expected to feed into “food, goods and services inflation”. That language highlights growing concern about second-round inflation effects rather than a purely temporary energy shock.

At the same time, the ECB acknowledged that the economic cost of the conflict is mounting. Growth forecasts were revised lower, with GDP now expected at 0.8% in 2026, 1.2% in 2027 and 1.5% in 2028. The Bank cited the war’s impact on commodity markets, real incomes and confidence as key reasons behind the downgrade. The result is an increasingly stagflationary outlook, with inflation moving higher even as growth slows.

Despite the hawkish inflation assessment, the ECB stopped short of signaling another rate increase. Instead, policymakers stressed that the outlook remains uncertain, with “upside risks for inflation and downside risks for economic growth.” The Governing Council reiterated its data-dependent and meeting-by-meeting approach and emphasized that it is “not pre-committing to a particular rate path.” Markets are therefore left with a central bank that is clearly worried about inflation but still cautious about tightening too aggressively into an increasingly fragile economy.

ECB Staff Projections Comparison

Headline Inflation (%)

Key takeaway: ECB significantly raised near-term inflation forecasts, reflecting the prolonged energy shock and its broader pass-through into the economy.

Core Inflation (%)

Key takeaway: The increase in core inflation forecasts is arguably more important than the headline revision. ECB now expects energy costs to feed into food, goods and services prices, signaling greater concern about second-round inflation effects.

GDP Growth (%)

Key takeaway: Growth forecasts were trimmed for 2026 and 2027 as the war’s impact on energy prices, confidence and real incomes weighs on activity. However, ECB sees slightly stronger medium-term recovery by 2028.

Full ECB statement here.