The European Central Bank has delivered a 25-basis-point rate increase, aligning with market expectations.

At Thursday's meeting, the ECB's Governing Council decided to raise all three key interest rates by 25 basis points, citing persistent inflation pressures stemming from the ongoing Middle East conflict. Inflation is now anticipated to remain significantly above the target level for an extended period. This move represents the latest step in the central bank's tightening campaign amid sustained price pressures.

The rate adjustment becomes effective on September 16, 2026, lifting the deposit facility rate, the main refinancing operations rate, and the marginal lending facility rate to 2.50%, 2.65%, and 2.90%, respectively. Alongside the decision, the ECB published updated staff projections that revise inflation expectations higher for 2027 and 2028, prompting markets to adopt a more cautious view on the peak policy rate.

The Governing Council reiterated its commitment to a "data-dependent, meeting-by-meeting" approach, making no pre-commitments regarding the future trajectory of rates. The ECB President is scheduled to hold a press conference at 14:45 local time today to elaborate on the decisions. Traders have left their rate expectations unchanged, pricing in one additional hike during 2026.

Inflation Outlook Raised, Overshoot Persists

The latest ECB staff projections indicate average headline inflation of 3.0% for 2026, unchanged from the June forecast. Projections for 2027 and 2028 stand at 2.5% and 2.1%, respectively, both revised upward from previous estimates. Core inflation, which excludes energy and food, also remains elevated, with three-year projections of 2.5%, 2.6%, and 2.3%—all exceeding the 2% policy target.

The Governing Council noted that risks to the inflation outlook are tilted to the upside, with the energy shock triggered by the Middle East conflict serving as the primary source of uncertainty. ECB staff have developed multiple scenarios examining different intensities, durations, and second-round effects of the energy shock to assess how growth and inflation might evolve under varying assumptions. The results indicate a wide range of potential outcomes.

Growth Projections Slightly Upgraded, Yet Downsides Remain

Despite sustained inflation pressures, the euro area economy has demonstrated greater resilience than anticipated. The ECB has revised its growth forecast for 2026 upward to 0.9%, with 2027 expectations lifted to 1.4% and 2028 projected at 1.5%. The upgrades for 2026 and 2027 relative to the June projections are primarily attributable to the economy's stronger-than-expected performance.

However, the Governing Council emphasized that risks to the growth outlook are tilted to the downside, creating a counterbalance to the upside risks in inflation. Overall, the economic landscape remains highly uncertain.

Flexible Policy Toolkit Maintained, Transmission Protection Ready

On the balance sheet front, the securities portfolios under the Asset Purchase Programme (APP) and the Pandemic Emergency Purchase Programme (PEPP) continue to decline at a predictable pace, with the Eurosystem no longer reinvesting principal payments from maturing securities.

The Governing Council stated it stands ready to adjust all of its policy instruments within its mandate to ensure inflation returns sustainably to the 2% target over the medium term. The Transmission Protection Instrument (TPI) also remains available to counter unwarranted market turbulence that could threaten monetary policy transmission across euro area member states.