Christine Lagarde

The European Central Bank kept interest rates unchanged on Thursday, holding steady as it waits to see how much of a lingering energy shock from the Middle East conflict will feed through into eurozone inflation.

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The ECB’s governing council held the deposit facility rate at 2.25%, with the main refinancing rate staying at 2.4% and the marginal lending facility at 2.65%.

Monetary policy for the eurozone is set through these three key interest rates, with the deposit facility rate serving as the main benchmark.

“The outlook for energy prices, while highly volatile, currently stands close to the baseline of the June Eurosystem staff projections and well above the levels recorded prior to the conflict in the Middle East,” the central bank’s statement read.

“Uncertainty remains high and the full inflationary impact of the energy shock has yet to play out. The Governing Council is therefore closely monitoring the intensity and duration of the shock, as well as its indirect and second-round effects,” it added.

The decision follows confirmation last week that eurozone inflation eased to 2.8% in June from May’s 3.2%, the first decline this year, with core price growth slowing to 2.4%.

The pause comes just six weeks after the ECB raised rates for the first time in nearly three years, responding to a war-driven energy shock that had pushed inflation to its highest since September 2023.

ECB President Christine Lagarde has been careful to keep the door open.

At the central bank’s Sintra forum, Lagarde insisted June’s move was not an “insurance hike” but a response to a genuine inflation problem, with projections showing a return to the 2% target only in late 2027, and only if monetary policy tightened further.

Lagarde also refused to pre-commit to a path, saying “forward guidance is not currently in the cards.”

July is not a forecasting round and economists at ING, for example, had argued the bank would prefer to wait for September’s fresh projections, when they see a second hike as the more realistic outcome.

The complication is that the shock behind June’s hike is back.

Oil neared $120 a barrel in March before sliding to around $72 after an interim peace agreement at the end of June, but the truce has frayed badly this month, with the US and Iran exchanging fresh strikes, attacks on tankers and renewed sanctions pushing Brent back above $90 a barrel.

A prolonged rise in energy prices would feed through to household bills and headline inflation in the second half of the year, precisely the second-round effects central bankers currently fear.

The ECB and its peers

As the chart shows, Frankfurt tightened from previously being far below its peers.

The Federal Reserve’s target range sits at 3.50% to 3.75% and the Bank of England’s rate at 3.75%, while the Swiss National Bank is parked at zero.

Both of the ECB’s larger counterparts decide again next week.

The Fed announces next Wednesday, with futures markets assigning roughly an 89% probability to a hold, according to CME’s FedWatch tool, after June’s unanimous decision and projections signalling no cuts this year.

The Bank of England follows the next day, on 30 July, with new forecasts in tow and economists overwhelmingly expect a hold at 3.75%, although a Reuters poll found nearly 40% see at least one hike before year-end, after two policymakers voted for an increase to 4% in June.

For now, the ECB is the only major Western central bank to have actually raised rates in this cycle.

Eurostat’s final figures, published on Friday, showed annual inflation easing from 3.2% in May to 2.8% in June, the first decline since prices began accelerating in January, less than a week before the ECB’s Governing Council announces its policy decision on Thursday and decides whether June’s first interest-rate hike in nearly three years should be followed by another increase.

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The details of the release lean towards a pause.

Core inflation, which strips out energy, food, alcohol and tobacco, slowed from 2.6% to 2.4%, energy inflation cooled from 10.8% to 8.5% and services eased from 3.5% to 3.2%, with the headline rate falling in 22 of the EU’s 27 member states.

Among the eurozone’s big four economies, Germany stood at 2.4%, France at 2%, Italy at 3% and Spain at 3.6%.

The numbers matter because of what came before.

In June, the ECB lifted its deposit facility rate from 2% to 2.25%, its first increase in nearly three years, after the war in Iran drove eurozone inflation to 3.2% in May, the highest reading since September 2023.

A reignited Iran war

The complication is that the shock behind that hike has returned.

Oil neared $120 a barrel in March before sliding to around $72 following an interim peace agreement at the end of June, but the truce has frayed badly this month.

The US and Iran have exchanged fresh strikes, Tehran has attacked ships and threatened regional energy exports, and Washington has reimposed sanctions and stepped up its naval blockade, pushing Brent crude back up to $87 a barrel on Friday.

That resurgence has revived the possibility of a surprise hike on Thursday, according to ING, although the bank still expects a hold, with a second increase more realistic in September.

Renewed conflict involving Iran

The complication is that the shock behind that June rate hike has returned.

Oil prices neared $120 a barrel in March before sliding to around $72 following an interim peace agreement at the end of June. However, the truce has frayed badly this month.

The United States and Iran have exchanged fresh strikes, Tehran has attacked commercial shipping and threatened regional energy exports, while Washington has reimposed sanctions and tightened its naval blockade, pushing Brent crude back up to $87 a barrel on Friday.

The renewed escalation has revived the possibility of a surprise rate hike on Thursday, according to ING, although the bank still expects the ECB to hold rates steady, viewing a second increase as more likely in September.

July is also not a forecasting meeting, giving policymakers cover to wait for updated economic projections before taking further action.

What Lagarde has signalled

Speaking at the ECB’s Sintra forum a few weeks ago, ECB President Christine Lagarde insisted June’s rate hike was not an “insurance hike” but a response to a genuine inflation problem. She noted that the ECB’s projections showed inflation returning to its 2% target only in late 2027, and only if monetary policy was tightened further.

Lagarde also refused to pre-commit to a policy path, saying “forward guidance is not in the cards” and that decisions would continue to be made on a meeting-by-meeting basis, guided by incoming economic data.

The ECB remains the only major Western central bank to have actually pulled the trigger.

The US Federal Reserve left its benchmark interest rate unchanged at 3.50%-3.75% in June, at Kevin Warsh’s first meeting as chair, although his hawkish tone unsettled markets.

The Bank of England also left its Bank Rate unchanged at 3.75% in a 7-2 vote, with two policymakers preferring an increase to 4.0%, while the Bank of Japan raised its policy rate to a 31-year high of 1.0%.

The European Central Bank (ECB) took the digital euro project into its next operational stage on Tuesday by naming 36 payment service providers to help test the future currency in a large-scale pilot programme beginning in the second half of 2027.

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According to the ECB, the participants were selected from more than 50 applicants across the euro area and will work alongside the ECB and 19 of the euro area’s national central banks, excluding Bulgaria and Malta, during a 12-month testing exercise.

The pilot is intended to assess the digital euro’s technical infrastructure, operational processes and user experience, allowing person-to-person and person-to-business payments to be tested in both online and offline environments, before any decision is taken on issuing the currency.

The announcement moves the digital euro closer to practical testing with consumers, merchants and payment providers, making it one of the project’s most significant milestones since the ECB launched its preparation phase in late 2023.

The selected providers include traditional banks, digital banks and payment companies, with several of Europe’s largest financial institutions among those taking part, including Deutsche Bank, UniCredit, Revolut, Adyen and Stripe.

ECB Executive Board member Piero Cipollone said the level of interest demonstrated that the payments industry was ready to help shape the project’s next phase.

“The strong market interest in the pilot shows the private sector’s readiness to engage actively and quickly advance with the digital euro project to strengthen the European payments landscape,” Cipollone stated.

“We look forward to deeper engagement as we work with and learn alongside European payment service providers in developing a secure, efficient and inclusive digital euro,” Cipollone concluded.

Legislative approval remains the decisive milestone

The pilot comes as negotiations continue between the European Parliament, the Council and the European Commission on legislation that would establish the legal basis for a digital euro.

The ECB has consistently maintained that it cannot issue the currency unless the legislation is adopted by EU lawmakers.

Current planning foresees formal approval in 2027, followed by completion of the pilot and a possible public launch in 2029, although those timelines remain dependent on the legislative process.

The digital euro would be available free of charge to consumers through supervised payment providers and the ECB has repeatedly sought to counter concerns that it could lead to the disappearance of physical money or weaken privacy protections.

In the current plan for the launch, the digital euro would not pay interest and holdings would likely be capped to avoid significant outflows from commercial bank deposits.

Speaking to Euronews exclusively last week, ECB President Christine Lagarde welcomed the European Parliament’s decision to begin negotiations on the legislation and reiterated that the digital is intended to complement, rather than replace, cash.

“Cash and the digital euro will both be legal tender, which means that nowhere in Europe can someone say, ‘Sorry, I’m not taking your banknotes’,” Lagarde told The Europe Conversation with Maria Tadeo, reaffirming that cash would remain a permanent feature of Europe’s monetary system.

The digital euro is also designed to reduce Europe’s dependence on international payment providers and strengthen the bloc’s strategic autonomy in payments.

Lagarde also told Euronews that the project is about reinforcing Europe’s economic sovereignty as much as modernising payments, pointing to the bloc’s continued reliance on foreign-owned payment networks.

“We depend predominantly on US, but also sometimes Chinese, networks to organise payments. We need to have a European solution because we want to be sovereign at home,” Lagarde stated.