ECB lifts interest rate to 2.5% as energy shock raises inflation risk

The European Central Bank raised its main interest rate to 2.5%, saying renewed conflict in the Middle East had increased the risk that inflation would last longer than previously expected.

The ECB also raised its forecast for eurozone growth in 2026 to 0.9%, from 0.8% in June. It expects inflation to average 3% this year.

Energy prices drive inflation concerns

Oil and gas prices rose after US and Iranian attacks on ships near the Strait of Hormuz. Brent crude moved above $105 a barrel before easing to about $104.50, up 3.3% on the day.

UK gas prices rose above 203p per therm, their highest level since December 2022. Dutch wholesale gas prices, the EU benchmark, passed €80 per megawatt hour for the first time since January 2023; the front-month contract reached €82.56.

ECB President Christine Lagarde said inflation could persist longer than expected. She added that higher oil and gas prices were likely to push up food inflation, which had remained at 1.2%.

Government borrowing costs climb

Higher energy prices increased borrowing costs for major governments. The yield on 10-year UK government bonds reached 5.36%, its highest level since August 2007.

Germany’s 30-year bond yield rose to 5.08%, while its 10-year yield reached 3.45%. France’s 10-year yield climbed to 4.344%, its highest since October 2008.

EU gas storage was 67% full, below the five-year average of 84%. European buyers had delayed replenishment while expecting the conflict to end and prices to fall.

US Treasury Secretary Scott Bessent said the US would buy back $6bn of government debt to ease a bond-market sell-off. Investors considered the package insufficient, sending the 10-year Treasury yield to a three-year high.

Lagarde said the ECB had not discussed a predetermined path for future decisions. The bank expects headline inflation to return roughly to target by the end of 2027, partly because of the effects of higher interest rates.