ECB holds key rate at 2.5% as euro zone inflation hits three-year high of 3.8%

The European Central Bank left its key interest rate unchanged at 2.5% on Thursday, holding the deposit facility steady after a 25 basis point increase in September, even as euro zone inflation climbed to a three-year high.

Headline inflation in the euro area reached 3.8% last month, the highest level since September 2023, with energy price inflation at 18.8% amid continued turbulence in the Middle East.

The Governing Council said in a statement that rising energy prices posed upside risks to the inflation outlook and downside risks to growth, while underlying inflation and wages had so far remained broadly stable.

"At this point in time we are not seeing second round effects in addition to what is already included in the projections" released in September, ECB President Christine Lagarde told CNBC's Annette Weisbach during a press conference.

Lagarde said the main developments since the ECB's last meeting were higher energy costs — across oil, petrol, fuel, gas and refining margins — and a sharp rise in long-term financing costs, with the average 10-year sovereign yield up by around 35 basis points.

Governing Council decided unanimously

She said the Governing Council debated whether a hike was appropriate, but decided unanimously to hold, citing accumulating uncertainty, broadly unchanged underlying inflation and the appropriateness of a "measured approach" at this point.

Markets still see tightening ahead: money markets were pricing around a 67% probability of a rate hike in December following the announcement, according to LSEG data. The dollar extended gains against the euro in the wake of the decision.

The ECB hiked rates in June for the first time since 2023, after the outbreak of the U.S.-Israeli war with Iran in February renewed energy price pressures.

Growth supported, confidence at risk

The euro area economy continued to expand in the third quarter, with a recovery in services since the start of the Middle East conflict, the Governing Council said. Manufacturing, digital services and exports are being boosted by AI-related investments, while government spending on infrastructure and defense is supporting business activity. However, energy price pressures are likely to hit consumer confidence as higher financing costs weigh on growth.

Lagarde said the ECB would continue monitoring rising French borrowing costs and increased fragmentation that has spooked some market watchers. She attributed rising long-end borrowing costs worldwide to expectations for inflation and interest rates as well as "debt issuance by some of the hyperscalers," which she said were issuing more long-term bonds and driving up competition.

Deutsche Bank chief European economist Mark Wall said predicting the path of ECB monetary policy is becoming more challenging, and questioned whether the two hikes already delivered and the tightening of financial conditions since September are enough to lean against rising energy inflation risk. He said he expects one more hike to 2.75% in December, "and that's probably the end of the hiking cycle." He also noted that Lagarde announced earlier on Thursday that she will depart as ECB president.

Dean Turner, chief euro zone and U.K. economist at UBS Global Wealth Management, said the decision "should be viewed as a hawkish pause rather than the end of the tightening cycle," adding that the ECB's focus remains on ensuring energy-driven inflation does not become more persistent.

Source: CNBC.