The European Central Bank has moved back toward tighter policy. On Sept. 10, its Governing Council unanimously raised all three key interest rates by 25 basis points. The deposit facility rate, which now largely sets the cost of money across the eurozone, will rise to 2.5% from Sept. 16.
The rate on the main refinancing operations will increase to 2.65%, while the marginal lending facility rate will rise to 2.9%. It is already the second increase of 2026: in June, the bank also added a quarter-point in response to the energy shock triggered by the widening war in the Middle East.
The reason for the latest move is clear in the August data. Annual inflation across the 21 countries of the eurozone accelerated from 2.9% in July to 3.3%, its highest level in a prolonged period. Energy was the strongest source of pressure, with prices 14.3% higher than a year earlier.
This is fundamentally different from a classic case of an overheating economy. Services rose 3%, non-energy industrial goods by 1.2%, and food, alcohol and tobacco by roughly 1.2% as well. The main inflationary impulse came not from excessive demand, but from the energy market.
Daycom’s analysis indicates that the ECB’s interest rate is now being forced into an uncomfortable role. The bank cannot produce more gas or reopen a shipping route for tankers, but it can make money more expensive to stop an energy shock from spreading into wages, services, rents and long-term inflation expectations.
That risk of spillover is what worries the central bank most. If energy prices remain high only briefly, their impact gradually fades from inflation statistics. If the shock lasts for months, companies begin passing higher costs into prices, workers seek compensation through wages, and what began as temporary inflation becomes more persistent.
So far, the most dangerous version of that scenario has not emerged. Growth in compensation per employee slowed in the second quarter to 3.3% from 3.5%, while unit labor costs eased to 2.6% from 3.5%. That suggests the energy shock has not yet set off a full wage-price spiral.
That is why the ECB is not signaling an automatic sequence of further increases. Christine Lagarde described the September decision as straightforward and unanimous, but stressed that future moves would be taken meeting by meeting. The bank is once again refusing to pre-commit to a fixed path for rates.
The updated forecast, however, shows why stopping here may not be easy. Average inflation is expected at 3% in 2026, 2.5% in 2027 and 2.1% in 2028. The projections for the latter two years were revised upward from June, meaning the return to target is now expected to take longer.
The forecast for underlying inflation excluding energy and food is particularly revealing. It is expected to average 2.5% this year, 2.6% next year and 2.3% in 2028. In other words, even after the direct energy effect fades, part of the inflationary pressure may remain embedded in the wider economy.
Under the baseline scenario, headline inflation is expected to peak at around 3.6% in the fourth quarter of 2026. After that, base effects and an anticipated easing in energy prices should gradually pull inflation lower, to about 2.5% by the second quarter of 2027.
But the entire scenario depends on the assumption that the energy shock will gradually fade. The bank itself acknowledges a high degree of uncertainty around that assumption. The war in the Middle East, disruption to shipping and unstable supply routes could make today’s forecast obsolete within weeks.
For oil, the baseline technical assumptions imply an average price of about $89.5 a barrel in 2026 and $78 in 2027. Gas is estimated at around €51 per megawatt-hour this year and €43.3 next year. Even those levels are far above the projections made before the current conflict.
Gas poses an especially sensitive risk for Europe. Compared with the June forecast, the expected price for the third quarter was revised upward by roughly 20%, and compared with projections made at the end of 2025 it has approximately doubled. Low storage levels in Europe are one of the reasons.
That makes the coming winter a separate macroeconomic risk. If the weather is colder than usual and fresh disruptions cut supply, Europe will need to buy more gas in an expensive market. Household bills, utilities’ costs and industrial expenses would then rise at the same time.
In an adverse scenario, oil could approach $100 a barrel by the end of the year and gas about €75 per megawatt-hour. In the most severe scenario used for stress-testing risks, the figures are roughly $130 for oil and €130 for gas. That is not a forecast, but an estimate of the tail risk.
The distinction matters. The central bank is not saying that the worst-case scenario will happen, but it has to set policy so that it remains credible even if prices move significantly higher. Lagarde said a 25-basis-point increase was justified under all three energy scenarios considered by the bank.
At the same time, the eurozone economy has proved stronger than expected only months ago. The new baseline forecast sees GDP growth of 0.9% in 2026, 1.4% in 2027 and 1.5% in 2028. The projections for this year and next have both been upgraded.
That resilience reflects several factors at once. Consumption absorbed the initial energy shock better than expected, governments are spending more on defense and infrastructure, and investment tied to digitalization and artificial intelligence is supporting parts of the economy.
The labor market has also avoided a sharp deterioration. Eurozone unemployment remained at 6.4% in July. Employment and labor-force growth are slowing, but productivity is gradually improving, helping companies absorb some higher costs without immediately raising prices.
For the ECB, that is both good and complicated news. A stronger economy can withstand higher interest rates more easily, but it also reduces the chance that inflation will quickly fade because demand is weak. The resilience protecting Europe from recession therefore gives the central bank more room to tighten policy further.
The cost of that room is already visible in lending. After the June increase, the average rate on bank loans to companies rose from about 3.6% in May to 3.8% in June and July. The cost of market-based corporate debt was close to 4% in July.
For businesses, that means more expensive investment, working capital and refinancing. A company that is simultaneously paying more for gas, electricity and credit is more likely to postpone construction of a new plant or modernization. That is the mechanism through which higher rates cool economic activity.
Households feel the same process through mortgages, consumer loans and bank behavior. Higher rates make borrowing more expensive and saving more attractive. People spend less today, demand weakens, and companies find it harder to pass every increase in costs on to customers indefinitely.
The problem is that this mechanism works with a lag. A rate increase announced in September will not reduce a gas bill in October. Its purpose is to influence decisions on borrowing, wages, investment and pricing over the following months, when the original energy shock may already look very different.
The central bank therefore risks making mistakes in both directions. If it moves too cautiously, temporary energy inflation could become embedded in the wider economy. If it tightens too aggressively, high rates could suppress growth after energy prices have already started to fall.
That is the central dilemma of September. The ECB sees inflation materially above 2%, yet a large part of that inflation is coming from a sector monetary policy barely influences directly. The rate increase is not aimed at the price of a barrel of oil, but at preventing the second-round effects of that price.
For now, long-term inflation expectations remain close to 2%. For the central bank, that is one of its most important defensive lines. If companies and workers believe prices will stabilize again within a few years, they have less reason to build permanently high inflation into contracts today.
Short-term expectations, however, are elevated, and the longer energy prices remain high, the harder that confidence will be to preserve. That is why policymakers will watch wage settlements, services inflation, corporate margins and the pace at which energy costs are being passed into the rest of the economy.
There is also a fiscal dimension. Higher market rates increase the cost of new government borrowing at a time when many countries are simultaneously financing defense, infrastructure, the energy transition and social programs. That makes any new broad-based compensation for expensive energy much more costly for public budgets.
That is why the advice to governments sounds different from the first major energy crisis: support should be temporary, targeted and precisely designed. Blanket subsidies that sustain demand for all consumers can increase public debt while also making the inflation fight more difficult.
Another source of tension is the global bond market. Government borrowing costs have risen across many major economies, tightening financial conditions even before central banks act. If that move becomes disorderly, policymakers could find themselves fighting inflation while markets are already conducting part of the tightening on their behalf.
For the eurozone, this is especially sensitive because member states carry very different levels of public debt. The same ECB rate applies to 21 economies with different budgets, banking systems and sovereign financing costs. A sharp divergence in bond yields could therefore disrupt the transmission of a common monetary policy.
The ECB still has a dedicated transmission-protection instrument that can be used against unjustified and disorderly market moves. Its very existence reflects a basic paradox of the eurozone: the bank must raise rates for everyone while making sure that the process does not trigger a financial crisis in one member state.
The September decision also matters because it returns Europe to a cycle that had seemed finished after the previous inflation surge. The bank spent a long period lowering rates, but the new war altered the path of energy prices and forced monetary policy to respond once again to a geopolitical shock.
The June increase to 2.25% could still be interpreted as an insurance move. September’s 2.5%, combined with higher inflation projections for 2027 and 2028, presents a different picture: the bank now allows for the possibility that the problem will last beyond a few months of expensive oil and may affect domestic prices for longer.
That does not mean another increase in December is guaranteed. The ECB deliberately avoided giving such a signal. Before the next decisions, it will receive new data on inflation, wages, lending, growth and, most importantly, whether the energy market begins to stabilize.
If oil and gas prices fall and there is no strong second-round effect, 2.5% may prove close to a sufficiently restrictive level. If new supply disruptions drive energy prices higher again while services and wages accelerate, the case for another increase will strengthen.
The most dangerous outcome for Europe is not simply high inflation or simply weak growth, but the two together. More expensive energy raises prices while simultaneously eroding household real incomes and the profits of energy-intensive industries. Monetary policy then has to treat one problem at the risk of worsening the other.
So far, Europe has avoided that scenario. The eurozone is still growing, unemployment remains low, and the energy crisis has not triggered broad wage acceleration. That resilience is what allowed the ECB to raise rates now without expecting an immediate recession.
But the next few months will test that resilience more severely than the summer did. Europe is entering the cold season with expensive gas, lower storage levels and geopolitical risks the central bank cannot control. Under those conditions, even one new disruption to energy routes could change both the inflation and growth outlook at once.
The ECB’s 2.5% rate is therefore more than another figure for financial markets. It shows that energy security is once again directly shaping the cost of credit, sovereign debt, mortgages and investment in Europe, just as it did during previous energy crises.
The bank can make money more expensive and prevent inflation from becoming entrenched. But it cannot end a war, guarantee gas supplies or lower the price of oil by administrative decision. The future path of rates therefore increasingly depends on events taking place far beyond Frankfurt.
And that is the central risk for the European economy: after years spent trying to return inflation to 2%, Europe is once again in a position where price stability may be determined less by domestic demand than by the next turn in the war, energy routes and the winter ahead.
