ECB Hikes Interest Rates to Prevent Inflation Shock, May Not Tighten Further

The European Central Bank (ECB) appeared to be set on keeping interest rates unchanged throughout 2026 at the beginning of this year. However, a sharp rise in oil and natural gas prices due to supply disruptions triggered by the US-Iran conflict pushed inflation above target again.

Policymakers became increasingly concerned that higher energy costs could spill over into other goods and services, making inflation more persistent through second-round effects. The ECB raised its deposit rate by 25 basis points in June to prevent what was initially viewed as a temporary energy shock from becoming a broader inflation problem.

QNB's latest economic commentary discusses three key factors supporting the assessment that the ECB has reached the end of its tightening cycle. Firstly, the inflation risks that prompted the June rate hike have eased, with recent data showing that higher energy costs are not feeding broadly into the economy. Both headline and core inflation surprised to the downside in June, while wage growth continues to moderate, limiting the risk of second-round effects.

Secondly, the weakening growth outlook for the euro area reinforces the case for no further increases in policy rates. Business activity has remained subdued, with the composite Purchasing Managers' Index staying below the 50-point threshold that separates expansion from contraction for the past three months. Slower economic growth is likely to reduce underlying inflationary pressures by dampening demand across the economy.

Thirdly, recent ECB communication suggests that policymakers are becoming more comfortable leaving interest rates unchanged. At the June meeting, the Governing Council emphasized that it would continue to follow a data-dependent and meeting-by-meeting approach, without pre-committing to a specific path for policy rates. This message was reinforced at the ECB's annual Forum on Central Banking, where central bankers noted that risks to inflation and growth had become more broadly balanced.