ECB refuses to look through the energy shock, but growth caps the path
The ECB delivered the expected 25bp hike, lifting the deposit rate to 2.25%.
The move was framed around the 2% medium-term inflation target and the inflation pressure generated by the war in the Middle East. This makes the decision more than a mechanical response to higher energy prices. It is a credibility hike, despite President Lagarde’s protestations, designed to show that the ECB will not simply look through an energy shock if the risk of broader pass-through is rising.
The new projections make that logic clear. Headline inflation is now expected to average 3.0% in 2026, 2.3% in 2027, and 2.0% in 2028, while inflation excluding energy and food is seen at 2.5% in both 2026 and 2027. Granted, the initial shock is energy-led, but the ECB now sees enough risk of indirect and second-round effects to justify action.
That said, this is not a clean demand-driven inflation cycle. Growth has been revised lower, with euro area activity now expected to expand by only 0.8% in 2026, 1.2% in 2027, and 1.5% in 2028.
Lagarde also highlighted a weaker domestic demand outlook, softer services surveys, and cooling labour demand, even as the labour market remains broadly resilient. Higher energy prices are eroding real incomes, weighing on confidence and threatening to drag on investment and output if supply chains and shipping routes remain disrupted.
So, while the decision is hawkish in its motivation, guidance remains cautious.
The repeated emphasis on price stability, data dependence, meeting-by-meeting decisions, and no pre-commitment is not a dovish reversal; rather, it reflects the challenge inherent in balancing growth and inflation that are headed in different directions.
For the euro, implications are mixed. This hike should limit downside because it confirms that the ECB is prepared to defend credibility if the energy shock broadens. But the move itself was already priced, and the growth language limits how far markets can extrapolate the tightening cycle. Evidence that Lagarde is willing to keep further hikes on the table if underlying inflation, wages, and service prices remain sticky is likely needed for the euro to retrace higher.