Geostrategic conflicts are persisting, and the outcomes remain uncertain. It is increasingly likely that this will drive a sustained rise in oil and natural gas prices, which could be reflected in higher energy and electricity costs over the autumn and winter. The euro area economy nevertheless continues to outperform expectations, and the incoming data for the third quarter is encouraging.
Under these circumstances the Governing Council of the ECB has decided to raise its key interest rates by a quarter of a percentage point, having left them unchanged at the previous meeting in July. The interest rate on the deposit facility, which best reflects the monetary policy stance, thus stands at 2.5%. Our assessment is that this interest rate level gives us the flexibility to respond appropriately to all possible outcomes of the war and their potential consequences for inflation. We will maintain our approach to future decision-making, deciding on monetary policy measures on a meeting-by-meeting basis.
The latest macroeconomic data shows the euro area economy to be more resilient to the effects of the energy shock than had previously been expected. The high energy prices driven by the prolonged conflict in the Middle East are however causing inflation to remain elevated. Accordingly the latest macroeconomic projections for the euro area, which were discussed by the Governing Council at its latest meeting, suggest that inflation and economic growth in the euro area will be slightly higher over the projection horizon than forecast under the previous projections. Inflation is forecast to rise to 3.0% this year, primarily in reflection of the uptick in energy price inflation driven by the high prices of oil and natural gas on global markets. Under the assumption of the gradual normalisation of the situation in the Middle East and an easing of energy prices, inflation is then forecast to slow to 2.5% in 2027 and 2.1% in 2028. Economic growth in the euro area is forecast to strengthen from 0.9% this year to 1.4% in 2027 and 1.5% in 2028, and will be broadly based according to the projections.
The financial markets are also largely being shaped by high and volatile energy prices. The outlook is uncertain, and there are additional concerns over the low energy inventories going into the winter, particularly of gas in Europe. These risks, in conjunction with the resilience of the euro area economy, are raising market inflation expectations over the coming years above 2%. The markets have therefore raised their expectations regarding the restrictiveness of ECB monetary policy, and are not ruling out the possibility of the interest rate on the deposit facility rising to 3.25% by mid-2027. Despite the challenging environment, the situation in the private sector remains favourable. Investor demand for newly issued private-sector bonds is robust, which is reducing risk premiums despite the large volume of new issuances. Share prices remain high, supported by expectations of growth in earnings at listed firms. At the same time the pricing-in of a longer period of higher interest rates at global central banks and the rise in public debt in major advanced economies are putting upward pressure on global government bond yields.
In light of this data, the Governing Council decided at yesterday’s meeting to raise the key interest rates by 25 basis points. The interest rate on the deposit facility, which best reflects the monetary policy stance, now stands at 2.5%. In a situation of great uncertainty regarding the size and persistence of the energy shock, we believe that this interest rate level constitutes an appropriate response to the subsequent unfolding of events. The Governing Council’s future decisions will remain focused on seeing inflation stabilise at its 2% target rate over the medium term. The next steps will be based on an assessment of the inflation outlook and the risks surrounding it, the dynamics of underlying inflation, and the strength of monetary policy transmission. The monetary policy stance will continue to be decided on a meeting-by-meeting basis.