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Mortgage holders could face higher repayments after the European Central Bank (ECB) increased interest rates on Thursday, warning that the war in the Middle East is driving inflation higher across the euro area.
Announcing the decision following a meeting of its Governing Council on Thursday afternoon, the ECB said it had decided to raise its three key interest rates by 25 basis points because the conflict was creating inflation pressures through higher energy prices.
“The war in the Middle East is generating inflation pressures,” the ECB said.
“The decision to raise rates is robust across a range of scenarios mapping out how the shock might evolve and affect the medium-term outlook for the euro area.”
The increase means the ECB’s deposit facility rate will rise to 2.25%, while its main refinancing rate will increase to 2.40% from June 17th.
The decision is likely to be closely watched by mortgage holders and borrowers, as ECB rates influence the cost of lending across the euro area.
The central bank said inflation is now expected to average 3.0% in 2026, 2.3% in 2027 and 2.0% in 2028.
It noted that these forecasts had been revised upwards since March due to rising energy costs.
“Compared with March, staff have revised up their baseline projection for inflation in 2026 and 2027 owing to a higher path for energy prices, which, to some extent, is expected to feed into food, goods and services inflation,” the ECB said.
ECB President Christine Lagarde said energy prices were increasingly feeding through into the wider economy.
“Inflation rose to 3.2% in May from 3% in April,” Lagarde said.
“Energy price inflation ticked up to 10.9% in April, while food price inflation fell from 2.4% to 2%. Inflation excluding energy and food picked up to 2.5% from 2.2% in April, as goods inflation edged up to 0.9% and services inflation increased from 3% to 3.5%.”
Lagarde warned that inflation is expected to remain elevated for an extended period.
“The increase in energy prices will lift inflation further over the summer and keep it well above target into the first half of 2027,” she said.
“It will also have an impact on food, goods, and services inflation. Inflation should then return to target in the second half of ’27, supported by falling energy prices and slower increases in other prices.”
She said the ECB would be paying close attention to whether rising energy costs begin to push up wages and broader prices throughout the economy.
“If energy prices were to rise by more and for longer than currently expected, euro area inflation would increase further,” Lagarde said.
“This could be reinforced and become more persistent if higher energy prices were to spill over by more than expected to other prices and to wages.”
Alongside the inflation concerns, the ECB also downgraded its growth outlook for the euro area.
The central bank now expects economic growth of 0.8% this year, 1.2% in 2027 and 1.5% in 2028.
Lagarde said the conflict was weighing on confidence and reducing spending power.
“Staff now expect domestic demand to be weaker than they projected in March as the war weighs on confidence and higher energy costs erode real incomes,” she said.
The ECB said the outlook remained uncertain, citing the possibility of further energy market disruption and broader economic fallout from the conflict.
“The outlook remains uncertain, with upside risks for inflation and downside risks for economic growth,” the ECB said.
“The full implications of the war for medium-term inflation and growth will depend on the intensity and duration of the energy price shock, as well as the scale of its indirect and second-round effects.”
The ECB stressed that future decisions would continue to be taken on a meeting-by-meeting basis.
“We are not pre-committing to a particular rate path,” Lagarde said.
Mortgage lending across the euro area was growing by 3% annually in April, while the average mortgage lending rate stood at 3.4%, according to figures released by the ECB alongside Thursday’s decision.
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