Borrowing costs are rising again across the eurozone as conflict in the Middle East pushes up energy prices. The European Central Bank raised its key deposit rate to 2.5% while upgrading its growth forecast on the back of resilient manufacturing and consumer spending.

The European Central Bank (ECB) raised all three of its main interest rates by 0.25 percentage points on Thursday. The deposit rate will rise from 2.25% to 2.5% on 16 September.

“The conflict in the Middle East continues to generate inflation pressures, and inflation is set to remain well above target for an extended period,” ECB President Christine Lagarde said at a press conference in Berlin.

It marks the bank’s second increase this year. The ECB raised rates in June for the first time in almost three years before leaving them unchanged in July.

Inflation could remain high into 2027

Eurozone inflation accelerated from 2.9% in July to 3.3% in August, reaching its highest level for three years. Energy-price inflation reached 14.3% in August, partly because of higher refining margins and commodity prices. The ECB said conflicts in the Middle East and Ukraine had increased pressure on the wider energy outlook.

“This is likely to keep headline inflation well above target into the first half of 2027,” Ms Lagarde said. The ECB expects inflation to average 3% this year and 2.5% in 2027, up from its previous forecast of 2.3%. It expects inflation to return to approximately 2% towards the end of next year.

Higher ECB rates generally feed through to mortgages, business loans and other forms of credit. Households with variable-rate mortgages could face higher repayments, while people seeking new loans may receive more expensive offers. Savers could benefit if banks pass on the increase through higher deposit rates.

The ECB hopes higher borrowing costs will prevent the energy shock from feeding through into wages and prices across the economy. However, it has not committed to another increase. “We are not taking a view as to which direction we go at our next meeting,” Ms Lagarde said. “We are in this uncertainty that can change things almost overnight.”

Economy proves more resilient than expected

Despite the rate increase, the ECB raised its eurozone growth forecast for this year from 0.8% to 0.9%. It now expects growth to accelerate to 1.4% in 2027, compared with the 1.2% predicted in June.

“The economy proved resilient in the second quarter despite headwinds from the energy shock,” Ms Lagarde said. Growth was broad-based across countries and sectors, while unemployment remained at 6.4% in July.

We are in this uncertainty that can change things almost overnight.
— Christine Lagarde, ECB President

“Manufacturing continues to perform solidly as governments spend more on defence and infrastructure,” she added. Recovering consumer confidence also helped services withstand the initial energy shock, while increased activity connected to artificial intelligence appeared in digital services, business investment and exports.

The stronger economy gives the ECB more room to contain inflation without tipping the eurozone into recession. However, the bank warned that inflation could exceed its forecasts while growth falls short, particularly if further disruption raises energy prices or a cold winter coincides with low gas-storage levels.