ECB Holds Rates Steady as War in Middle East Intensifies Inflation Risks

Key facts

• ECB kept deposit facility rate at 2.00%, main refinancing rate at 2.15%, and marginal lending rate at 2.40%.
• The Governing Council cited intensified upside risks to inflation and downside risks to growth.
• War in the Middle East has caused a sharp increase in energy prices, pushing up inflation.
• The euro area entered the crisis with inflation near the 2% target and a resilient economy.
• Longer-term inflation expectations remain well anchored, but short-term expectations have risen significantly.
• The ECB will follow a data-dependent, meeting-by-meeting approach with no pre-commitment to a rate path.
• Asset purchase programs (APP and PEPP) continue to decline as reinvestments cease.

Rates Held Amid Escalating Energy Crisis

The European Central Bank left its three key interest rates unchanged on Thursday, as the war in the Middle East drives energy prices sharply higher, complicating the outlook for inflation and growth. The deposit facility rate remains at 2.00%, the main refinancing rate at 2.15%, and the marginal lending facility at 2.40%. The decision comes as the Governing Council acknowledged that upside risks to inflation and downside risks to growth have intensified. The council stated that incoming information is broadly consistent with its previous assessment of the inflation outlook, but the energy price shock from the conflict is now a dominant factor.

War in the Middle East Fuels Energy Price Surge

The war in the Middle East has triggered a sharp increase in energy prices, which is pushing up inflation and weighing on economic sentiment across the euro area. The Governing Council noted that the implications for medium-term inflation and economic activity depend on the intensity and duration of the energy price shock, as well as the scale of indirect and second-round effects. "The longer the war continues and the longer energy prices remain high, the stronger is the likely impact on broader inflation and the economy," the council said. The euro area entered this period of surging energy prices with inflation already near the 2% target, and the economy has shown resilience in recent quarters.

Inflation Expectations Diverge Across Horizons

While longer-term inflation expectations remain well anchored, expectations over shorter horizons have moved up significantly, reflecting the immediate impact of higher energy costs. The Governing Council emphasized its commitment to ensuring that inflation stabilizes at the 2% target over the medium term. The council is not pre-committing to any particular rate path and will continue to follow a data-dependent, meeting-by-meeting approach. Decisions will be based on its assessment of the inflation outlook and the risks surrounding it, in light of incoming economic and financial data, underlying inflation dynamics, and the strength of monetary policy transmission.

Asset Purchase Programs Continue to Wind Down

The portfolios of the Asset Purchase Programme (APP) and the Pandemic Emergency Purchase Programme (PEPP) are declining at a measured and predictable pace, as the Eurosystem no longer reinvests principal payments from maturing securities. This gradual unwinding is part of the ECB's broader strategy to normalize monetary policy. The Governing Council stands ready to adjust all of its instruments within its mandate to ensure inflation stabilizes at the 2% target and to preserve the smooth functioning of monetary policy transmission. The Transmission Protection Instrument remains available to counter unwarranted, disorderly market dynamics that pose a serious threat to monetary policy transmission across euro area countries.

Outlook Clouded by Uncertainty and Data Dependency

The ECB's decision underscores the heightened uncertainty facing the euro area economy. The war in the Middle East adds a new layer of complexity to an already challenging environment, with energy prices acting as both an inflationary force and a drag on growth. The Governing Council will closely monitor the situation and remains well positioned to navigate the current uncertainty, according to its statement. The President of the ECB is scheduled to comment on the considerations underlying these decisions at a press conference starting at 14:45 CET.

The bottom line

• The ECB kept rates unchanged at 2.00%, 2.15%, and 2.40%, citing intensified risks from the Middle East war.
• Energy price surge from the conflict is pushing up inflation and weighing on economic sentiment.
• Long-term inflation expectations remain anchored, but short-term expectations have risen significantly.
• The ECB will follow a data-dependent, meeting-by-meeting approach with no pre-commitment to rate moves.
• Asset purchase programs continue to decline as reinvestments cease.
• The Transmission Protection Instrument is available to counter disorderly market dynamics.