ECB raises rates by 25bp, cites Middle East war

The European Central Bank raised its three key interest rates by 25 basis points at its June meeting, a decision robust across staff scenarios.

President Lagarde noted the euro area economy, despite 0.3 percent real GDP growth in Q1 2026, is slowing due to the Middle East war, particularly in services.

Manufacturing has held up, supported by inventory building and defense spending.

Inflation rose to 3.2 percent in May from 3.0 percent in April, primarily driven by energy prices, which exceeded 10 percent.

Core inflation also increased to 2.6 percent in May.

While short-term inflation expectations have risen, longer-term expectations remain anchored around 2 percent.

Eurosystem staff project headline inflation at 3.0 percent in 2026, 2.3 percent in 2027, and 2.0 percent in 2028.

The outlook remains uncertain, with upside risks for inflation and downside risks for growth.

The ECB will maintain a data-dependent, meeting-by-meeting approach.

President Lagarde detailed the ECB's monetary policy strategy for navigating frequent supply shocks, a key focus of its 2025 assessment.

The strategy is built on three principles: first, carefully assessing the shock's nature, including its size, persistence, and propagation into other prices and wages.

Second, emphasizing risks around the baseline and using alternative scenarios to capture potential disproportionate deviations from the inflation target.

Third, tailoring and graduating the policy response.

The June rate hike aligns with a 'measured adjustment' case, as the current shock is too large to ignore, but lacks evidence of de-anchoring expectations or strong second-round effects.

This agile, data-dependent approach avoids pre-commitment to a specific rate path, allowing for adjustments as the shock evolves.