ECB raises interest rates for the first time in three years as Iran war fuels inflation

The European Central Bank has lifted its deposit facility rate by 0.25% to 2.25%, marking a decisive pivot back to tightening as the Iran war pushes eurozone inflation to its highest level in nearly three years. The European Central Bank has raised interest rates for the first time in nearly three years, lifting its deposit facility rate from 2% to 2.25% following its governing council meeting on Thursday. 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 ECB’s deposit facility rate was last raised in September 2023, when it reached its peak of 4.0% after a tightening cycle meant to stabilise the post-pandemic inflation crisis. The ECB also raised its main refinancing operations rate to 2.4% and its marginal lending facility rate to 2.65%. The hike in the key interest rates marks a clear reversal of the easing cycle that had defined the ECB's approach throughout much of 2025 and, with eurozone inflation hitting 3.2% in May, its highest reading since September 2023, driven by a 10.9% surge in energy prices. Essentially, the governing council concluded that inaction was no longer tenable. Ahead of Thursday's meeting, financial markets had priced in a hike with near certainty as ECB governing council members signalled a rate increase in June from both the hawkish and dovish ends of the spectrum. Eurozone economy under pressure The hike arrives at a difficult moment for the eurozone economy. The bloc’s economy shrank by 0.2% in the first quarter of 2026, prompting economists to warn of a period of stagflation, combining weak growth with rising inflation and deteriorating confidence. The ECB's own Survey of Professional Forecasters placed full-year 2026 GDP growth at just 0.9%, a downward revision attributed directly to the negative impact of higher energy prices stemming from the Iran war. Inflation rose to 3.2%, the highest level since 2023, and core inflation, which strips out volatile food and energy components, also climbed from 2.2% in April to 2.5% in May, undermining any argument that the price pressures remain confined to energy alone. For households and businesses across the 21-country bloc, the decision translates into higher borrowing costs on mortgages and corporate loans, at a time when purchasing power is already being squeezed by elevated fuel and gas prices. Markets are also pricing in roughly a 50% probability of a further hike in September, suggesting Thursday's move is seen as the opening of a new tightening phase rather than a targeted, one-off intervention. Economists sounded the alarm The intellectual case for Thursday's hike was made beforehand and most forcefully by ECB Executive Board member Isabel Schnabel, the policymaker responsible for the bank's market operations. Schnabel argued that the ECB should raise rates in June regardless of whether ongoing Iran peace talks produce a deal, citing the conflict's duration and the degree to which high energy prices were spilling into the broader economy. Speaking at a conference in Seoul, Schnabel had warned that "the risk of de-anchoring inflation expectations is rising" and that the bank could no longer "look through this shock". Chief Economist Philip Lane also said conditions had worsened since the bank's March projections and that the June meeting would bring an upward revision to the ECB's inflation forecast. Schnabel went further, predicting inflation could rise to 4% before the year is out. This is a developing story and will be updated as more information becomes available.