European Central Bank raises deposit rate to 2.5% as energy prices drive inflation

Rate decision and policy stance

The European Central Bank Governing Council unanimously raised its benchmark deposit facility rate by 25 basis points to 2.50% during its monetary policy meeting in Berlin. The decision lifted the main refinancing operations rate to 2.65% and the marginal lending facility rate to 2.90%, marking the second rate increase of 2026 following a June hike that ended a pause dating back to September 2023. Borrowing costs reached their highest level since April 2025. ECB President Christine Lagarde confirmed that the central bank will maintain a data-dependent, meeting-by-meeting approach without committing to a predetermined rate trajectory. Financial analysts, including Candriam Chief Investment Officer Nicolas Forest and Peter Goves of MFS Investment Management, described the communication as restrictive, keeping further rate increases possible before year-end.

In the current circumstances, we do not attach great importance to the neutral rate.

Inflation drivers and economic projections

The monetary tightening responds to accelerating price pressures, with eurozone headline inflation rising to 3.3% in August from 2.9% in July, even as core inflation excluding energy moderated to 2.1%. Energy markets experienced strong increases, with Brent crude exceeding 105 dollars per barrel and European TTF natural gas reaching 82 euros per megawatt-hour, an increase of over 155% since the onset of the Iran conflict. The ECB raised its medium-term inflation outlook, projecting 3.0% in 2026, 2.5% in 2027, and 2.1% in 2028, compared to March projections of 2.3% and 2.0% for the outer years. The baseline scenario projects inflation peaking at 3.6% in the fourth quarter of 2026 and 2027 GDP growth of 1.4%, while an adverse severe scenario projects inflation reaching 5.4% and 2027 GDP growth slowing to 0.4%.

Financial markets and geopolitical tensions

European sovereign bond markets experienced widespread selling following the rate announcement. The German two-year Bund yield rose 12 basis points to 3.19%, marking its highest level since 2023, while sovereign spreads expanded against French ten-year paper. The decision occurred in a climate of international friction, with United States and Iranian forces intensifying clashes around the Strait of Hormuz alongside ongoing military actions in Ukraine. Before appearing at the Republican convention in Dallas, Texas, Donald Trump addressed the conflict in the Middle East ahead of the November 3 midterm elections.

I think the war is going to end right after the election because they cannot hold on any longer. They are desperate to try to influence the election.

Impact on European household borrowing

The rate hike translates into immediate cost increases for variable-rate mortgage holders across the eurozone. The 12-month Euribor crossed 3% after standing at 2.804% in May, while financial association ASUFIN projected the benchmark would reach 3.2% by the end of September. In Spain, where inflation reached 4.3% on higher fuel prices, a 100,000-euro mortgage over 25 years faces an increase of 55.74 euros per month, or 668.84 euros annually. A 150,000-euro loan over 25 years rises by approximately 73 to 75 euros monthly, and a 350,000-euro debt incurs an additional 173 euros per month. Roams mortgage expert Pablo Vega noted that commercial lenders are increasing scrutiny on applicants with higher debt ratios or unstable incomes.