As fully expected, The ECB hiked its key rate by 25bps (for the first time since 2023) as the policymakers battle with the dilemma of economic weakness combined with rising inflation.
Obviously, raising rates to dampen inflation could further slow the economy, while easing rates to support growth increases the risk that higher inflation becomes persistent.
Clearly, Lagarde et al went with the former with its well-jawboned baseline having long been a hike in June with risks skewed toward a follow-up move in September (although a move in July can’t be ruled out).
“The Governing Council is committed to setting monetary policy to ensure that inflation stabilizes at its 2% target in the medium term.
In line with this commitment, it today decided to raise the three key ECB interest rates by 25 basis points.
The war in the Middle East is generating inflation pressures, and the decision to raise rates is robust across a range of scenarios mapping out how the shock might evolve and affect the medium-term outlook for the euro area.”
On the ECB's growth/inflation dilemma, they wrote:
“The outlook remains uncertain, with upside risks for inflation and downside risks for economic growth.
The full implications of the war for medium-term inflation and growth will depend on the intensity and duration of the energy price shock, as well as the scale of its indirect and second-round effects.”
The ECB’s new economic projections revise inflation upwards for 2026 and 2027 due to “a higher path for energy prices, which, to some extent, is expected to feed into food, goods and services inflation.”
New (higher) inflation forecasts suggest more short-term pain with 2027 and 2028 seeing price pressures ease :
- *ECB SEES 2026 INFLATION AT 3%; PRIOR FORECAST 2.6%
- *ECB SEES 2027 INFLATION AT 2.3%; PRIOR FORECAST 2%
- *ECB SEES 2028 INFLATION AT 2%; PRIOR FORECAST 2.1%
Growth is seen slowing in the same period due to the impact of the war on commodity prices, real incomes and consumer confidence.
New (lower) GDP forecasts follow a similar path with short-term weakness rotating into modest improvement in 2027 and 2028 (but not exactly thrilling growth still):
- *ECB SEES 2026 GDP GROWTH AT 0.8%; PRIOR FORECAST 0.9%
- *ECB SEES 2027 GDP GROWTH AT 1.2%; PRIOR FORECAST 1.3%
- *ECB SEES 2028 GDP GROWTH AT 1.5%; PRIOR FORECAST 1.4%
As Bloomberg's Alessandro Migliaccio notes, the new economic projections paint a grim picture.
The higher inflation will strengthen the ECB’s conviction that a rate increase was needed to keep to its mandate of price stability.
The slower growth however, may see some countries grumbling against too much tightening.
EUR was flat ahead of the ECB decision and the initial market reaction is muted.
The rate hike was fully priced in, and traders had already anticipated upward revisions to inflation forecasts for 2026 and 2027.
As expected, and just like in March, the ECB has also produced new scenarios to account for the uncertainty it continues to face. These will be published together with the new projections after the press conference.
Watch the ECB press conference live here (due to start at 0845ET):