ECB lifts deposit rate to 2.5% as Middle East conflict fuels inflation, markets price further hikes

The European Central Bank raised all three of its policy rates by 25 basis points on Thursday, lifting the deposit facility to 2.50% from 2.25%, the main refinancing rate to 2.65% and the marginal lending facility to 2.90%, with the new levels taking effect on 16 September 2026. It is the second hike of 2026, following the June move that made the ECB the first major central bank to tighten in response to the war, and markets had priced a 100% chance of it according to LSEG data. The driver is energy: eurozone inflation hit 3.3% in August with energy inflation spiking to 14.3%, as the conflict threatened commodity transit through the Strait of Hormuz.

The new projections are what give the decision its hawkish edge. The ECB now expects headline inflation to average 3.0% in 2026, 2.5% in 2027 and 2.1% in 2028, with the 2027 and 2028 figures revised higher, and it upgraded its growth forecasts at the same time while stressing that decisions remain data-dependent with no pre-set path. Excluding energy and food, the bank sees 2.5% in 2026, 2.6% in 2027 and 2.3% in 2028. President Christine Lagarde warned that the Middle East conflict and developments in Russia's war on Ukraine will keep headline inflation well above the 2% target for an extended period, and the Governing Council described an outlook with "risks to the upside for inflation and to the downside for economic growth".

Markets moved immediately. The euro weakened 0.3% to around $1.159, eurozone government bond yields edged up to fresh multi-year highs, and the rate-sensitive two-year German yield sat near 3.072%, up from 3.058% before the decision. The STOXX 600 was last down 0.7%, while oil surged more than 4% to $105.3 a barrel, reinforcing the inflation concern behind the move. Market pricing now implies a 90% chance of a third hike before year end, and CNBC reported more than a further two hikes priced into the curve.

Where the cycle ends is genuinely contested. A Deutsche Bank survey of its clients found no consensus: more than a third expect a 2.75% peak, one in four expect the ECB to hold at 2.5%, and another quarter see a 3% terminal rate. Aviva Investors' head of rates Ed Hutchings said "it's clear more hikes will be coming, and potentially more than one" while cautioning that with more than two further hikes priced, "things may well have gone too far", and Aberdeen economist Felix Feather expects another move at the December meeting. Investors will be watching energy prices, core inflation prints and the Governing Council's forward guidance for the timing of the next step.