Europe | New policy season after the ECB rate hike

ECB President Christine Lagarde said at Thursday’s press conference, following the 25-basis-point interest rate hike, that the decision was a “no-brainer”—an obvious one (even though, according to her, no other options were discussed at any point during the meeting). The decision was also unanimous. It is true that the hike had already been priced in, particularly after the hawkish tone of the July meeting and recent statements by ECB officials—not only those traditionally in favor of tighter policy, but even some of the more dovish members.

The hike is further supported by eurozone GDP growth in the third quarter, which came in at 0.6% quarter over quarter, well above expectations, although Lagarde seemed to indicate that the ECB had only taken into account the initial estimate, which was already a strong 0.4%. Consumer spending has held up well, there are signs of investment spending in defense—as expected—as well as in technology and AI, and confidence indicators have improved, all pointing to stronger growth. Lagarde explicitly emphasized that the ECB had been surprised by this resilience, prompting it to revise its GDP growth forecasts from 0.8% to 0.9% for this year and from 1.1% to 1.4% for next year. This is a substantial revision and reflects a degree of optimism on the ECB’s part.

That optimism contrasts with the risks associated with the war in Iran. One of the two major economic developments of the summer—the other being the rise in U.S. long-term interest rates—has been the continuation of the confrontation between Iran and the United States following the expiration of the 60-day temporary ceasefire, which was not particularly well observed. The conflict is not over and appears likely to drag on. Although the closure of the Strait of Hormuz has so far had less of an impact on oil prices than might have been expected, thanks to increased supply from other sources, the release of reserves, and some reduction in demand, the balance remains unstable. Sooner or later, the effects could become nonlinear if the situation is not resolved.

Somewhat higher oil prices over the summer—together with natural gas prices, which are particularly important for Europe—have pushed August inflation above expectations. This also supported this week’s rate hike and prompted the central bank to revise its inflation forecasts upward. Even so, core inflation has not delivered any recent upside surprises, helped by favorable food price developments. The ECB does not appear to anticipate significant second-round effects in its forecasts and notes that wage trends remain favorable, although it warns that such effects could emerge further down the road.

This relative optimism about growth, combined with the warnings on inflation, suggests that rates could rise further toward the end of the year, possibly reaching 2.75% in December. Markets have recently even begun pricing in an additional hike, to 3%. Lagarde took care during the meeting to point out that the neutral interest rate—which some interpret as the upper limit that rates might reach in the current hiking cycle—is a shifting range, signaling that levels of 2%–2.5% should not be viewed as constraining the institution’s future decisions.

Overall, the ECB is entering the new policy season with a more firmly hawkish stance, in a year that will be full of economic, political, and geopolitical challenges. U.S. protectionism has given way to other trade pressures—most notably Chinese competition—with key trade policy decisions ahead. Long-term interest rates have risen globally and face additional upward pressure from the fiscal proposals of some European political parties, against the backdrop of a particularly busy 2027 election calendar. Meanwhile, military tensions on Europe’s eastern flank intensified over the summer, adding to the Gulf crisis and further increasing uncertainty. There will be plenty of difficult waters to navigate in the months ahead.