Middle East fighting complicates ECB rate decision

Fresh fighting in the Middle East and renewed energy price rises have complicated the European Central Bank's decision on whether to raise interest rates again this week.

The ECB raised borrowing costs in June for the first time since 2023 after eurozone prices rose following the conflict. A decision to hold rates at the central bank's meeting on Thursday had appeared likely after Washington and Tehran struck a deal aimed at ending the war and inflation started moving back towards the ECB's 2% target.

The source said fighting has flared again between the two sides, Iran has declared the Strait of Hormuz closed, and oil prices have risen again. Most analysts cited in the report still expect policymakers to keep the benchmark rate unchanged at 2.25%.

Berenberg bank senior economist Felix Schmidt told AFP that he did not expect any change to interest rates at the meeting. He said oil prices had not risen too sharply and that there were no major signs of wider knock-on effects in the eurozone, such as higher inflation spreading through a broader range of goods and services.

ING economist Carsten Brzeski said there was a small chance the ECB would raise rates, but that holding rates was still the most likely outcome. He said the meeting could bring a final clash between policymakers who favour higher rates and those who support looser policy before the summer break.

The ECB was described in the source as the first major central bank to raise rates after the outbreak of the US-Israeli war against Iran at the end of February. The Bank of Japan later raised rates to a 31-year high, while the US Federal Reserve and the Bank of England have so far held off. The Fed, Bank of England and Bank of Japan are all due to meet in the final week of July.

The source said one reason the ECB may hesitate to raise rates again is criticism of its June increase, with some economists arguing it was unnecessary and would weigh on households and businesses in the struggling eurozone. The bank will also not have new growth and inflation forecasts at this week's meeting, because it publishes projections at every second meeting and released a new set in June.

Investors will watch ECB President Christine Lagarde's news conference for signals on the future path of rates, although the source said she is usually cautious in what she says. She is also likely to face questions about her own future after saying in an interview this month that she did not rule out resigning as ECB chief to provide a European voice in the French presidential election next year.

Some observers expect another rate increase in September, while others say the outlook is more uncertain. Schmidt said a lot can happen in eight weeks.