ECB Recap: Hawkish Interest Rate Hike Despite Growth Downside Risks
The European Central Bank (ECB) has raised the Deposit Facility Rate to 2.50%, the Refinancing Rate to 2.65%, and the Marginal Lending Facility to 2.90%, effective from 16 September. This decision was accompanied by a clear warning that the outlook remains highly uncertain, with risks skewed to the upside for inflation and to the downside for growth.
The latest staff projections show average headline inflation at 3.0% in 2026, 2.5% in 2027, and 2.1% in 2028. The 2026 forecast remains unchanged from June, but projections for 2027 and 2028 have been revised upwards. Core inflation, excluding energy and food, is expected to remain above target, with averages of 2.5% in 2026, 2.6% in 2027, and 2.3% in 2028.
Lagarde stated that the economy has proven resilient, supported by consumption, public investment, and a recovery in the services sector. Furthermore, manufacturing remains strong, consumer confidence has rebounded, and the labour market is solid, although employment growth has slowed. The short-term growth outlook has improved, with business and housing investment expected to provide further support.
Nevertheless, the central bank faces difficult energy shocks: higher prices are expected to feed into core inflation and food costs, while worsening conflicts, supply disruptions, or an exceptionally cold winter could drive gas prices even higher. Consequently, the ECB will remain data-dependent and approach decisions on a meeting-by-meeting basis, without committing in advance to any specific interest rate path.
Overall, this is a hawkish hike, yet the risk of stagflation persists. The ECB raised interest rates because it forecasts that inflation will remain above target for longer, even though growth risks have increased. The combination of resilient domestic demand, higher inflation forecasts, and the potential for second-round effects opens the door for further tightening, although the Governing Council will await evidence regarding how persistent energy shocks may be.