ECB ups interest rates as Iran war fuels inflation fears

The European Central Bank raised interest rates today for the second time this year, seeking to quell an energy-driven rise in inflation triggered by the Iran war.

Attacks by both sides since the end of August have shattered a month of relative calm, with the US ⁠and Iran hitting military, shipping and energy assets.

That has sent oil prices back above $100 a barrel and revived fears about a wave of price hikes in the fuel-importing euro zone.

The ECB responded by raising its policy rate to 2.5% from 2.25%, saying inflation was expected to stay above its 2% goal for some time.

"The conflict in the Middle East continues to generate inflation pressures, and inflation is set to remain well above target for an extended period," the ECB said in a press release.

The move will automatically affect tracker mortgage customers whose repayments will rise by €13 per month for every €100,000 borrowed.

It will also put upward pressure on other mortgage rates over time.

But savers who shop around may be able to benefit from higher returns as some financial institutions are likely to pass on the increase in future.

Higher growth and inflation expectations

The European Central Bak also raised some of its growth and inflation projections, reflecting the economy's greater-than-expected resilience and the effect of higher fuel costs on other prices.

The ECB now sees inflation at 3% this year, 2.5% next year and 2.1% in 2028.

Today's forecasts are unlikely to fully capture the latest energy-price surge, however, particularly in natural gas, which many European countries rely on for heating.

"This is especially relevant because, while gas price shocks tend to feed through more slowly than oil price shocks, they also generate larger and more persistent ‌effects on non-energyinflation," Barclays said in a note.

Markets expect more rate hikes

Financial markets are pricing in one more rate hike this year, followed by another one or two moves next year.

Economists, in contrast, think today's move may be the ECB's last for now, although a growing number see a risk that further tightening may be needed.

The ECB did not drop any hint about future moves, merely repeating its standard line that decisions would be based onincoming data.

Investors will look for clues when ECB President ChristineLagarde holds her regular press conference later this afternoon.

"We expect President Lagarde to maintain a hawkish wait-and-see stance, leaving the door open to further tightening," Martin Wolburg, senior economist at Generali Investments, said.

Lagarde and colleagues, gathering in ‌Berlin for their annual venture away from the ECB's Frankfurt headquarters, are likely to have taken comfort from recent growth data.

The euro zone economy has been holding up better than anticipated despite higher fuel costs, competition from China and the impact of droughts.

Bank lending even picked up pace in July, suggesting ⁠the ECB's June rate rise had not dented activity and giving policymakers scope to tighten further today.

The ECB now expects the euro zone economy to grow by 0.9% in 2026, 1.4% in ‌2027 and 1.5% in 2028.

But policymakers will be watching a rise in government borrowing costs that has already tightened financing conditions.

Long-term bond yields have ⁠scaled highs not seen ‌since before the global financial crisis, reflecting inflation concerns and worries about ballooning government debt.

Competition from bond sales by big tech companies aggressively raising money to fund the AI boom has added to upward pressure on yields, while political turmoil in Germany has shaken its government bonds, the benchmark for the euro zone.

So far, economic indicators the ECB watches have broadly been benign.

Core inflation, which strips out energy and food prices, eased to 2.4% last month and the ⁠latest survey showed consumers had trimmed their expectations for price growth. Pay rises had also moderated.

"Unlike the 2022 energy shock, this year's energy price shock is unlikely to spark a wage-price spiral, as demand conditions are not as ⁠conducive to higher inflation," Andrew Kenningham at Capital Economics said.

ING's global head of macro Carsten Brzeski said companies, at least in Germany, had so far absorbed the higher costs, in marked contrast to 2022, when the energy shock following Russia's invasion of Ukraine pushed inflation above 10%.

Lagarde likely to face questions on her own future

Lagarde is likely to be asked at her post-decision press conference about her tenure as ECB president, which is scheduled to run until October 31, 2027.

She has repeatedly been linked to the leadership of the World Economic Forum, and spoke in July of her desire to champion European values in some capacity during the campaign fo or next year's French presidential election.

Pressed later that month on whether that meant leaving the ECB early, Lagarde merely said: "You are not going to see the back of ‌me before 2027."

A report last week suggesting that ECB board member Isabel Schnabel was in talks to join the International Monetary Fund could herald a reshuffle at the top of the euro zone's central bank.

Banks may up fixed rates for new customers in coming weeks

Daragh Cassidy, Head of Communications at Bonkers.ie. said that although the number of tracker customers has gradually declined over the years, there are still around 100,000 tracker mortgages in Ireland.

These borrowers will see their mortgage rate increase by another quarter of a percentage point within the next month or so.

Mr Cassidy noted that tracker mortgages are linked to the ECB's slightly higher main refinancing rate, which will rise from 2.4% to 2.65%.

"For someone with €150,000 remaining on their tracker over 10 to 15 years, their repayments will increase by around €17 or €18 a month, or just over €200 per year," he said.

"So they will now be paying over €400 a year more when you include the June hike. However, anyone on a tracker who is paying a margin of 1% or less is still getting a fairly good deal," he added.

Daragh Cassidy said that borrowers on fixed-rate mortgages are protected for now, as their repayments will not change until their fixed term expires.

But he said that lenders may increase their fixed rates for new customers in the coming weeks.

"The big three Irish lenders didn't respond to the last ECB rate hike, keeping both their variable and fixed rates unchanged," he said.

"This has led Irish mortgage rates to fall below the eurozone average in recent weeks, which is rare for Ireland. AIB, Bank of Ireland and PTSB are less exposed to changes in ECB rates because they fund a significant proportion of their lending through customer deposits," he added.

But he said he was not as confident that they will absorb a second quarter point hike, especially for their fixed rates.

"And they definitely won't absorb a third hike, which is currently a small possibility before the end of the year. So I'd advise anyone who is thinking of switching their mortgage to do it now as they can avail of rates as low as 3% currently," he advised.

Additional reporting by David Murphy