ECB hikes interest rates amid inflation and energy shock fears
The European Central Bank (ECB) raised interest rates for the first time since 2023, in an effort to slow inflation ahead of a surge in energy costs caused by the Iran war.
The move was triggered as the economy shrank in the first quarter, while inflation had already reached 3%, above the target of 2%, which forced the ECB to lift its key rate to 2.25% from 2%. This could mark the start of a hiking cycle, with the ECB deciding to act first largely because it has room to do so, with interest rates being neutral for the economy.
Additionally, the ECB has lowered its growth forecasts, projecting the economy will expand by 0.8% in 2026 and 1.2% next year, while also setting new baseline projections for inflation, which is set to go back to standard level of 2% by 2028.
US inflation rises
Meanwhile, US annual inflation rose to 4.2% in May, the highest since 2023, underscoring how elevated energy prices are rippling through the US economy. The yearly figure accelerated from 3.8% in April, with the energy index accounting for over 60% of the increase.
The Consumer Price Index (CPI) showed that prices rose 0.5% month over month, slightly cooler from 0.6% in April, largely driven by the ongoing conflict in Iran. Core prices rose to 0.2% in May, down from 0.4% recorded in the prior month and below the 0.3% predicted by economists.
The Federal Reserve is set to meet this week to review interest rate policy. Fed chair Warsh is under growing pressure to cut rates, but securing enough support for a reduction may prove challenging. Most economists expect the Fed to hold rates steady for now, though additional increases later in the year remain a possibility.
UK economy shrinks
Finally, the UK’s economy shrank by 0.1% in the month to April, as the Iran conflict is starting to have an impact on businesses.
Analysts expected the economy to slow over the next few months after a strong start to the year. They also expect the Bank of England to keep interest rates unchanged when it meets this week, although the ECB’s decision to raise interest rates has created some uncertainty.
The Office National Statistics stated that in the three months to April, the economy grew by 0.7% compared with the previous three-month period. The main driver of the negative growth was the services activity, which decreased by 0.2%, but this was partially offset by a 0.1% rise in construction output, while production remained unchanged.
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