For the first time in three years! The European Central Bank raised interest rates as inflation heats up, reiterating that it will not pre-commit to future policy paths.

The European Central Bank (ECB) raised interest rates by 25 basis points on Thursday as scheduled, increasing the deposit facility rate from 2% to 2.25%. This is the first rate hike by the central bank in three years. The ECB believes that with inflation pressures intensifying, it can no longer wait for the end of the Middle East conflict before taking action. Although the market currently expects the ECB to raise rates by another 25 basis points in September, the central bank reiterated that it will not commit to a future policy path in advance and stated that it still has the ability to deal with the current environment full of uncertainty. In its statement, the ECB said: "The outlook remains subject to uncertainty, with upside risks to inflation and downside risks to economic growth." "The impact of the war on medium-term inflation and economic growth will depend on the intensity and duration of energy price shocks, as well as the scale of their indirect effects and second-round effects." The ECB's rate hike this time is the first policy response by major central banks to the surge in energy prices caused by the Middle East conflict. As the conflict has entered its fourth month, Eurozone officials are concerned that inflation pressures are no longer limited to the energy sector. Even if the US and Iran reach a peace agreement in the future, damaged energy infrastructure in the Middle East means that it will take time to restore production, so inflation may not easily fall back. Currently, the latest inflation data in the Eurozone has risen to 3.2%, with inflationary pressures still intensifying. Even after excluding the volatile items of energy and food, core inflation pressures have risen significantly. Business price hikes, as well as long-term inflation expectations among residents, are also on the rise. Many policymakers have previously stated that the central bank can no longer turn a blind eye to this round of energy shocks and must maintain market confidence in the central bank's 2% inflation target. These concerns about the inflation outlook are reflected in the ECB's latest quarterly economic forecast. The new forecast shows that Eurozone inflation will reach 3.0% in 2026, higher than the 2.6% forecast in March; this inflation measure will fall to 2.3% in 2027 (higher than the 2% forecast in March) and return to the target level of 2% in 2028. The forecast also shows that excluding food and energy, core inflation will reach 2.5% in 2026 (higher than the 2.3% forecast in March) and remain at this level in 2027, before falling to 2.2% in 2028. At the same time, the forecast has lowered growth expectations for the Eurozone in the next two years. The ECB currently expects Eurozone GDP growth to be 0.8% in 2026, lower than the 0.9% forecast in March; GDP growth in 2027 is expected to be 1.2%, lower than the 1.3% forecast in March. This latest forecast also highlights the dilemma faced by the ECB - inflation remains high while the outlook for economic growth continues to weaken. ECB President Christine Lagarde will hold a press conference later today to further elaborate on her views. More details on the forecasts and scenario analysis will also be released later in the day. It is worth noting that the ECB was close to taking action in April, and even some of the most dovish policymakers hinted before this week's meeting that there was essentially no other choice now. They still remember the experience of 2022. At that time, the Russia-Ukraine conflict led to a record surge in inflation, and the ECB was criticized for its slow response. In that cycle, the deposit facility rate eventually rose to 4%, and then the ECB began to cut rates from the middle of 2024. This time, Eurozone officials are more cautious about inflation expectations as they have risen significantly. Some are concerned that damage to energy infrastructure in the Gulf region and increased global supply chain friction could further worsen the inflation situation. In contrast, central banks of other G7 countries are not rushing to take action. The Bank of Canada kept interest rates unchanged on Wednesday. Next week, the Federal Reserve and the Bank of England are expected to stay put, while the Bank of Japan is expected to continue its gradual tightening of monetary policy that began last year. A repeat of the interest rate hike disaster in 2011? Before the ECB's announcement of the interest rate decision today, the market was already widely anticipating that the central bank would take action. Officials seem to believe that it is necessary to raise rates now to prevent soaring energy prices from triggering a broader wave of inflation. However, some economists warn that the ECB's determination to defend its anti-inflation credibility may lead to costly mistakes. Some believe that there are still sufficient reasons for the ECB to remain cautious and wait and see - the Eurozone economy is stumbling, and market investors are prone to interpret a single rate hike as the beginning of a new cycle of consecutive rate hikes. Lessons from the past are vivid. In July 2008, the ECB chose to raise interest rates, but shortly after, Lehman Brothers went bankrupt, prompting the central bank to urgently reverse course and cut rates. However, more economists compare this to 2011, when then-President Jean-Claude Trichet raised borrowing costs twice, only for Mario Draghi to lower them by the end of the year after taking over. Policymakers that year were also concerned about the surge in commodities and energy prices, but underestimated the fragility of the Eurozone's financial system, leading to a double-dip recession in the entire region. TS Lombard economist David Owen said, "The European Central Bank is fixated on proving the credibility of its policy. The rate hike in 2011 was a complete policy mistake, and the central bank's excessive focus on inflation expectations and the psychological shadow left by the high inflation of 2022 make the risk of repeating the mistakes of that year the biggest one right now." Although Eurozone inflation indicators have risen, some analysts believe that the increase in core inflation is not entirely due to the transmission of energy costs. There are also views that core price indicators such as wages have not shown signals of excessive increase. Michala Marcussen, Chief Economist at Societe Generale, pointed out: "If the ECB raises interest rates hastily before there is clear evidence of the second round of inflation transmission effects, it faces unnecessary tightening risks, which is a risky move." Holger Schmieding, Chief Economist at Berenberg Bank, believes that raising interest rates by the ECB will only unnecessarily burden residents and businesses, and the soft economy itself will gradually alleviate inflationary pressures. He bluntly stated, "When people's lives are under pressure, there is absolutely no need for the central bank to raise interest rates. With domestic demand continuing to cool down, this round of temporary price increases is unlikely to evolve into a long-term inflation crisis that requires intervention through rate hikes." However, there is also a camp that supports rate hikes, believing that even if weaker economic data force a shift in central bank policy, rate hikes are still justified. Catherine Nayes, Chief Economist for Europe at PGIM, said that policymakers will leave enough room for policy flexibility for themselves, "so that they can send signals of a rate cut at any time when there is substantial deterioration in the economic fundamentals and continued weakness in various economic surveys."