ECB Holds Rates as Middle East Energy Shock Lifts Inflation Outlook, Weakens Growth

FRANKFURT, Germany — The European Central Bank on Thursday left interest rates unchanged as a new energy shock from the war in the Middle East clouded the outlook for prices and growth, warning that inflation risks are now tilted to the upside even as the eurozone economy slows.

Rates on hold, no promises on cuts

Meeting in Frankfurt on March 19, the ECB’s Governing Council kept its key deposit rate at 2.0%, the rate on main refinancing operations at 2.15% and the marginal lending facility at 2.40%. President Christine Lagarde said policymakers would continue to decide “meeting by meeting,” with no advance commitment on when borrowing costs might come down.

At the same time, the central bank’s staff raised projections for consumer prices and cut forecasts for economic growth through 2028, reflecting higher oil and gas prices following the escalation of conflict around Iran and the Strait of Hormuz.

“Incoming information, including the new staff projections, indicates that the near-term inflation outlook has worsened, largely because energy prices will be higher owing to the war in the Middle East,” Lagarde said in her introductory statement.

Inflation forecast revised higher

The new baseline forecast sees annual inflation in the 20-country euro area averaging 2.6% in 2026, up from 1.9% projected in December. Inflation is then expected to decline to 2.0% in 2027 before ticking up to 2.1% in 2028 as climate policies and carbon pricing add to energy costs.

The central bank emphasized that while headline inflation is close to its 2% target today — euro-area prices were rising at about 1.9% in February — the balance of risks has shifted with the latest energy shock. It described the risks to inflation as “tilted to the upside, especially in the near term,” and the risks to growth as “tilted to the downside.”

Measures of core inflation, which exclude volatile energy and food prices, are projected to ease only gradually, from 2.3% in 2026 to 2.2% in 2027 and 2.1% in 2028. The bank expects higher energy costs to spill over into production and transport, but to be offset over time by moderating wage growth, a stronger euro and increased import competition.

Growth outlook cut

Real gross domestic product is now expected to grow by 0.9% in 2026 and 1.3% in 2027, both slightly weaker than in the previous projection round, before stabilizing at 1.4% in 2028. The ECB said higher import bills for energy, increased uncertainty and tighter global financial conditions are weighing on demand.

The ECB said the labor market remains “broadly resilient,” with firms continuing to hoard workers despite weaker demand. That supports incomes but may squeeze corporate profit margins if the slowdown persists.

Energy shock central to the new projections

The projections incorporate a steep rise in oil and gas prices since late February, after attacks on Iranian leadership and energy infrastructure and disruptions to shipping in the Strait of Hormuz. Benchmark Brent crude climbed above $100 a barrel and briefly traded around $126 in early March, while European gas prices also spiked.

ECB staff based their baseline on market futures as of March 11 and developed adverse and severe scenarios in which energy prices rise further and stay higher for longer. In one adverse case, the projections assume oil prices near $120 a barrel and wholesale gas approaching €90 per megawatt-hour in the second quarter of 2026, alongside a sharper hit to activity.

For now, the Governing Council judged that holding rates steady was the best way to ensure inflation returns to target over the medium term without amplifying the shock.

“We are not pre-committing to a particular rate path,” Lagarde told reporters. “Our future decisions will continue to be data-dependent and will follow a meeting-by-meeting approach.”

She said policymakers will focus on four elements: the outlook for inflation, the risks around that outlook, measures of underlying price pressures such as core inflation and wages, and the strength of monetary policy transmission through financial markets and bank lending.

Market reaction and balance-sheet policy

Financial markets reacted nervously to the mix of higher inflation projections and weaker growth. Germany’s DAX 40 index fell more than 2.5% on the day of the decision to a 10‑month low, as investors weighed the implications of a prolonged period of relatively tight financial conditions in the face of an external energy shock.

The ECB confirmed that it will continue to shrink its balance sheet in the background. It is no longer reinvesting maturing securities under its older asset purchase program or the pandemic emergency purchase program, allowing holdings to roll off at what it called a “measured and predictable pace.” The bank also reiterated that its Transmission Protection Instrument, a backstop introduced in 2022, remains available to counter any “unwarranted, disorderly” market dynamics that threaten the smooth transmission of monetary policy across member states.

Fiscal warning: targeted, temporary support

With monetary policy constrained by the need to keep inflation expectations anchored, the ECB pointed to national governments as the first line of defense against the social fallout from higher energy prices.

“Fiscal policies should be designed to make our economies more productive and to support the green and digital transitions, while ensuring fiscal sustainability,” the Governing Council said. Any new support in response to the energy shock “should remain temporary, targeted and tailored,” it added, to protect the most vulnerable without fueling demand or locking in fossil fuel use.

That language echoes the guidance the bank offered during the 2022–23 surge in energy prices after Russia’s invasion of Ukraine, when it warned that broad subsidies and price caps could amplify inflation and delay the shift to cleaner energy.

A familiar dilemma returns

The latest shock comes at a different point in the cycle. Then, inflation had already surged well above target, and the ECB was racing to lift rates from negative territory. Today, it faces renewed upward pressure from a position in which inflation has been brought back close to 2%, but growth is fragile and public finances are more stretched.

Central banks in other advanced economies are facing similar tensions. The U.S. Federal Reserve and the Bank of England have both signaled that interest rates may have to stay higher for longer than previously assumed after revising their own inflation paths upward in March on the back of rising energy costs.

How the balance of risks evolves in Europe will depend heavily on developments far from Frankfurt. A rapid easing of tensions in the Middle East and a pullback in oil and gas prices could give the ECB room to start cutting borrowing costs later. A prolonged conflict and sustained energy disruption could force it to keep rates elevated despite weaker growth, leaving governments to manage the political and social strains.

For now, the central bank is signaling patience. It cannot control wars or shipping lanes, but its decisions will help determine how the costs of this latest shock are shared among prices, wages and employment — and how long the eurozone remains on the edge between inflation relief and renewed stagflation fears.