ECB holds rates as Lagarde warns inflation above target until 2027

The European Central Bank held interest rates steady on Thursday but warned that surging energy prices from the Middle East conflict will keep euro-area inflation above its 2% target through the first half of 2027.

The European Central Bank held its deposit rate at 2.25% on Thursday, warning that the energy shock from escalating Middle East hostilities will keep inflation above target until the first half of 2027.

"The outlook for energy prices, while highly volatile, currently stands close to the baseline of the June projections and well above levels recorded prior to the conflict," ECB President Christine Lagarde said at her post-decision press conference in Frankfurt.

The decision was unanimous, though Lagarde acknowledged some Governing Council members questioned whether a rate increase was warranted. The ECB's risk assessment reverted to its June baseline, removing the "more balanced" language from its Sintra meeting, as Brent crude surged past $98 a barrel on renewed US-Iran hostilities.

With oil prices approaching $100 and the ECB's September meeting featuring updated staff projections, markets are now pricing in 48 basis points of additional tightening by year-end. Lagarde confirmed she has ordered staff to prepare an in-depth analysis of oil and gas price scenarios for the September decision.

The ECB raised rates by 25 basis points in June, its first increase since the conflict began, directly informed by the same energy price analysis Lagarde cited Thursday. The last time the ECB held rates with this risk-assessment language was in April, preceding the June hike. Overnight index swaps now price a September increase as more likely than not, with traders assigning a 36% probability of a Fed hike next week as well.

The euro dropped 0.4% against the dollar to $1.1370 following the announcement, while the single currency was flat against the pound at 0.8538 pence. Brent crude extended gains to trade at $98.90 a barrel, up 4.2% on the day, after Yemen's Houthis targeted two oil tankers in the Red Sea and US strikes on Iran continued overnight.

Lagarde said the ECB has not yet observed second-round effects from the energy shock, with wage growth trending lower and medium-term inflation expectations remaining anchored. But she expressed concern about the risk, noting that companies plan to increase selling prices as input costs rise.

"Uncertainty remains high and the full inflationary impact of the energy shock has yet to play out," the ECB's statement said. The Governing Council "is therefore closely monitoring the intensity and duration of the shock, as well as its indirect and second-round effects."

How September Could Deliver 48bps of Tightening

The September meeting is shaping up as the ECB's next consequential decision point. Lagarde said the council will receive two monthly inflation prints, second-quarter GDP data, two consumer expectations indices, a compensation index and two PMI readings before deciding.

"We'll receive all this data and analyze it very carefully," she said. The ECB's updated staff projections will incorporate 2026 estimates, giving policymakers a clearer read on whether the adverse energy scenario — which could push euro-area inflation to between 3.5% and 4.4% — is materializing.

On her own future, Lagarde dismissed speculation about an early departure. "You won't see me go until 2027," she said, adding that "when there are clouds on the horizon, the captain stays on the ship." The comments follow weeks of market chatter about her potential return to French politics, with about one-third of economists surveyed by Bloomberg predicting she would not complete her eight-year term.

This article is for informational purposes only and does not constitute investment advice.