ECB Hikes Rates to 2.5% as Energy Prices Surge, Could the Fed Follow?

The European Central Bank (ECB) raised its deposit rate by 25 basis points to 2.5% on Thursday as a sharp rise in energy prices pushed eurozone inflation higher.

This represents the ECB’s second rate hike this year and the latest move by a major central bank to respond to an inflation shock linked to the conflict in the Middle East.

The decision leaves the door open to further tightening, although policymakers must also weigh the risk that higher borrowing costs could weaken economic growth.

ECB faces a new inflation problem as energy prices surge

European Central Bank President Christine Lagarde described the ECB’s decision to hold its policy stance as a “no-brainer” but warned that inflation could remain above the bank’s 2% target for longer than previously expected.

The renewed pressure comes as Brent crude has climbed above $100 a barrel amid U.S.-Iran tensions and disruption around the Strait of Hormuz. European gas prices have also surged, with the Dutch TTF benchmark rising about 190% since the start of the year.

Brent crude oil price chart. Source: Trading Economics

The energy shock is already feeding into eurozone inflation. Consumer prices rose 3.3% year over year in August, up from 2.9% in July, while energy inflation accelerated to 14.3% from 10.3%.

The ECB is particularly concerned that higher energy costs could spread through transportation, production, and household expenses, eventually pushing up wages and broader consumer prices. 

While interest rates cannot directly increase the supply of oil or gas, policymakers can raise borrowing costs to weaken demand and prevent a temporary shock from entrenched inflation.

For now, underlying price pressures offer some relief. Core inflation eased to 2.4% in August from 2.5% in July, while services inflation fell to 3%. Lagarde also said wages had yet to show a significant response to the energy shock.

Still, the ECB expects inflation to remain above target, forecasting headline inflation at 3% in 2026, 2.5% in 2027, and 2.2% in 2028.

Source: ECB and Nordea

Markets are already pricing in at least three additional rate increases over the next year, with some economists expecting the deposit rate to reach 3%. 

ECB officials, however, continue to stress that future decisions will depend on incoming data and energy prices.

Bundesbank President Joachim Nagel said the ECB could move into mildly restrictive territory if inflationary pressures worsen, while Estonia’s central bank governor Ülo Kaasik said further rate increases were understandable given the risk of higher fuel and food prices.

Could higher energy prices push the Fed to also hike rates in September?

The ECB’s decision also puts attention on the Federal Reserve, which is facing a similar question over whether higher energy prices will require tighter monetary policy in the United States.

The Fed is due to meet on September 15-16, with inflation data arriving immediately before the decision.

A Reuters poll found that 65 of 93 economists expected the federal funds rate to remain at 3.50%-3.75% at the September meeting, down from 90% in an August poll. The remaining economists expected a 25-basis-point increase.

Market pricing has been more cautious, with the probability of a September hike moving around 60% to 70%.

Source: CME FedWatchTool

The August consumer price report is therefore expected to play a major role in determining the Fed’s next move.

U.S. employment data has already strengthened the case for watching inflation closely. 

Employers added 162,000 jobs in August, well above economists’ expectations of 56,000, while unemployment remained at 4.1% as annual wage growth eased slightly to 3.1% from 3.2% in July.

The latest producer price data also showed renewed inflationary pressure from rising energy costs.

Economists expect the August consumer price index to increase 0.4% month over month, with core inflation rising 0.2%. Annual inflation is expected to remain around 3.4%.

Notably, the Fed faces an additional complication because some of the forces pushing prices higher are supply-driven. 

Energy prices and tariffs can raise costs without responding strongly to interest-rate increases, while heavy investment in artificial intelligence infrastructure has continued despite higher financing costs.

JPMorgan estimates that data center capital investment could reach $5.5 trillion by 2030. 

Barclays analysts have also said the U.S. economy may be less sensitive to interest rates than in previous cycles, with major technology companies continuing to commit large amounts of cash to AI infrastructure.

Other central banks also weigh response to rising energy prices

The ECB is not alone in facing renewed inflation pressure from rising energy costs. G10 central banks are reassessing monetary policy as higher oil and gas prices threaten to keep inflation elevated.

Australia has taken one of the most hawkish positions, raising rates three times this year to 4.35% and leaving the door open to another hike later this month.

Japan is also expected to raise rates to 1.25% next week, while New Zealand has lifted rates to 2.75% and signaled that further tightening remains possible.

Canada has similarly kept the door open to more hikes if inflation stays elevated. The Bank of England and Sweden are taking a more cautious approach, although markets still expect possible increases later this year.

Norway appears closer to the end of its tightening cycle, while Switzerland is expected to keep rates at 0% as its strong franc helps contain inflation.

The differing responses reflect the challenge facing central banks. Higher rates cannot increase oil or gas supply, but they can limit demand and prevent energy costs from spreading into wages and broader inflation.

The risk, however, is that tighter policy could weaken growth while households and businesses are already dealing with higher energy bills. Central banks therefore face a difficult choice between containing inflation and avoiding a broader economic slowdown.