ECB holds interest rates at 2% as inflation rises

The European Central Bank kept interest rates at 2 per cent on Thursday but left the door open to a rise in borrowing costs in June, as it warned that the risks to the Eurozone economy from the Middle East conflict had “intensified”.

ECB president Christine Lagarde said policymakers had discussed a potential interest rate rise this month “at length and in depth” but eventually unanimously agreed not to change monetary policy.

The central bank’s governing council will revisit the matter when it meets again on June 11, Lagarde told journalists.

“I think directionally I know where we’re heading,” she said, adding that this could still change as “there might be massive changes taking place”.

Carsten Brzeski, ING’s global head of macro, said: “The mention of a rate hike debate clearly suggests that the ECB has moved closer to a rate hike at the June meeting.”

The ECB’s decision came just hours after data showed Eurozone inflation jumped more than expected to 3 per cent in April, the highest level since September 2023, as the conflict in the Gulf drives up energy prices.

A first estimate of GDP growth in the 21-member Eurozone suggested it slowed to 0.1 per cent in the first three months of the year, down from 0.2 per cent in the previous quarter.

Claus Vistesen, economist at Pantheon Macroeconomics, called the inflation number, which was up from 2.6 per cent in March, “nasty” and warned that the situation “will get nastier still soon”.

Oil prices surged above $126 a barrel on Thursday, their highest level since the outbreak of the Iran war, before falling back later in the day.

While Lagarde pointed to a recent increase in short-term inflation expectations, she stressed that “longer-term” expectations remained “well anchored”.

For now, “we are not seeing second-round effects” from higher energy prices in other parts of the economy, she said.

ABN Amro economist Jan-Paul van de Kerke said the economy was weaker and inflation higher “than the ECB expected in its March forecasts”.

Lagarde acknowledged that the ECB was “certainly moving away from the baseline”, referring to three scenarios it published last month. Its baseline scenario had suggested a short and limited shock to inflation and growth from the Iran war.

However, she pushed back against any comparison to the stagflation years of the 1970s, when inflation and unemployment were both high and growth weak.

Unlike in the 1970s, “we will tame inflation”, Lagarde vowed.

“We don’t apply that flashy term to [the] circumstances that we have” at the moment, she added, referring to the word “stagflation”.

The ECB joined a wave of top central banks to hold interest rates this week as they gamble they can take more time to assess whether the energy shock will lead to a prolonged period of high inflation. 

The US Federal Reserve, Bank of Japan, Bank of England and Bank of Canada all kept policy unchanged at their respective meetings.

After the decision, traders continued to expect three quarter-point increases in Eurozone borrowing costs this year. However, the likelihood of the third rate rise fell back to roughly 75 per cent from a near-certainty at the start of the trading day, according to levels implied by swaps contracts.

Additional reporting by Ian Smith in London. Data visualisation by Keith Fray