ECB sees inflation near 3% as war keeps energy costs high

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ECB sees inflation near 3%

Highlights

Euro-area inflation may stay near 3%.
Energy costs keep inflation elevated.
Markets expect another ECB rate hike.

ECB Chief Economist Philip Lane expects consumer-price growth to hover around 3% for the remainder of the year, although the trajectory will depend heavily on developments in the Middle East, Bloomberg reported. The assessment comes after euro-area inflation reached 2.9% in July, moving further above the central bank's 2% target.

Energy shock keeps inflation elevated

The Iran conflict has altered the inflation outlook by raising oil and gas costs across Europe. Energy was already the fastest-rising major component of euro-area prices in June, increasing 8.7% from a year earlier, according to Eurostat data.

That pressure helps explain why the ECB has shifted back toward tighter policy. Policymakers raised interest rates by a quarter percentage point in June before leaving them unchanged in July. Investors now expect at least one additional increase before the end of 2026 as the energy shock keeps inflation above target.

Lane stopped short of signaling when another move could come, emphasizing instead that policy will respond to incoming economic and inflation data. The ECB will publish updated economic projections in September, giving policymakers a fresh assessment of how the conflict has affected prices and growth.

The June baseline forecast already projected average euro-area inflation of 3% in 2026, compared with 2.3% in 2027 and 2% in 2028. Under a severe scenario involving a larger and more persistent shock, inflation could reach 4% this year.

Growth gives the ECB room to act

The challenge for policymakers is eased somewhat by stronger economic activity. The 21-member euro area expanded 0.4% in the second quarter, twice the 0.2% pace economists had expected, despite elevated energy prices and geopolitical uncertainty.

That resilience gives the ECB more room to prioritize inflation without immediately confronting a severe downturn. But tighter borrowing conditions still carry costs for households and businesses, particularly through mortgages, corporate credit, and investment.

Food prices could become another source of pressure in 2027, with weather patterns including El Niño potentially affecting agricultural production and prices. That adds another layer of uncertainty to an outlook already dominated by energy.

Rates and markets face a longer test

For investors, inflation remaining near 3% makes a rapid return to easier monetary policy less likely. Expectations for another ECB hike could support euro-area bond yields and the euro while increasing financing costs for companies and governments.

Much now depends on whether the Middle East conflict eases. A sustained decline in energy prices could bring inflation closer to target and reduce pressure for further tightening. A prolonged disruption would strengthen the case for keeping borrowing costs elevated, leaving September's ECB projections particularly important for markets.

Earlier, we reported that the ECB selects 36 participants for the digital euro pilot.

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