ECB rate decision turns on energy shock and core inflation

The European Central Bank is expected to raise interest rates on Thursday, with euro zone inflation at 3.2% in May and energy prices up 10.9% from a year earlier. Markets are looking for a 25-basis-point increase in the deposit rate to 2.25%, a move that would tighten policy as the bloc absorbs a fresh oil-price shock tied to the Iran war.

The decision would come as policymakers weigh two risks at once: inflation running above the ECB’s 2% target and an economy that could be pushed from weak expansion into recession by higher borrowing costs. CNBC reported that the euro zone’s heavy reliance on imported energy leaves it exposed when oil prices rise, because higher fuel and power costs can pass through to transport, production and household bills.

The ECB has a narrower mandate than the U.S. Federal Reserve, with price stability at the center of its task. That makes the latest inflation mix a central issue for the Governing Council. Headline inflation has moved further above target, while core inflation, which strips out more volatile components, rose to 2.5% in May.

The rise in core inflation is drawing particular attention because it was driven mainly by services prices, according to CNBC. Services inflation can signal so-called second-round effects, where an initial shock from energy or other inputs spreads into broader prices and wages. For a central bank, that matters because an energy shock may fade, while broader price pressure can require tighter policy to contain.

Markets watch the ECB’s projections

Beyond the rate announcement, investors will examine the ECB staff forecasts for inflation and growth. Market pricing points to three rate increases over the rest of the year, according to CNBC.

Sven Jari Stehn, chief European economist at Goldman Sachs, wrote in a late-May note that he expected ECB staff to cut growth projections for 2026 and 2027 while lifting headline and core inflation forecasts. He said that would reflect “a more persistent energy shock and stronger indirect effects into prices.”

Stehn also wrote that Goldman Sachs’ energy price index, based on the average of oil and gas, had risen about 12% through the projection horizon since the ECB’s March meeting.

Anatoli Annenkov, senior European economist at Société Générale, wrote in a May note that the core inflation forecasts would be closely scrutinized, particularly the 2027 estimate. He said that forecast would show how much confidence ECB staff place in the arrival of second-round effects, especially given weaker activity data since March.

Mark Wall, a director at Deutsche Bank Securities, said in research published early this month that he expected the ECB to keep market pricing for rates “relatively unchanged.” He added that treating June as a one-off increase would not fit the ECB’s likely message.

The policy signal will therefore matter alongside the rate move itself. A quarter-point rise would mark an immediate response to above-target inflation, while the ECB’s forecasts and communication will shape expectations for how far it may be prepared to tighten if energy costs continue to feed into underlying prices.

This story draws on original reporting from CNBC.