ECB raises interest rates to 2.5% and warns Iran war is fuelling inflation

Christine Lagarde, president of the European Central Bank, speaks to the press in Berlin after the rate decision. Photograph: John MacDougall/AFP/GettyView image in fullscreenChristine Lagarde, president of the European Central Bank, speaks to the press in Berlin after the rate decision. Photograph: John MacDougall/AFP/GettyEuropean Central BankECB raises interest rates to 2.5% and warns Iran war is fuelling inflation Borrowing costs climb in Europe and oil tops $105 a barrel as bank says growing price pressures in eurozone will be ‘longer lasting than we had anticipated’

The European Central Bank has raised interest rates to 2.5% and warned that the risk of higher inflation over the next year has risen following renewed fighting in the Middle East.

It came as government borrowing costs soared on the back of a jump in oil and gas prices after the latest US and Iran attacks on ships in the strait of Hormuz.

The interest rate, or yield, on UK government debt rose to a 19-year high on Thursday, while the yield on US and European bonds also climbed in line with oil, which touched $105 (£78) a barrel.

Investors had expected the ECB to raise the cost of borrowing across the euro bloc, but were spooked by the hawkish tone of the central bank’s report, which warned of inflationary pressures building in many sectors of the economy.

Increasing its main rate from 2.25% to the highest level since March last year, the central bank lifted its forecast for eurozone economic growth in 2026 to 0.9%, up from 0.8% in June. It now expects inflation to average 3% this year.

The biggest driving force of rising prices is the cost of energy, which again jumped on Thursday after this week’s increase in US and Iranian attacks on ships transiting the Gulf.

Brent crude passed $105 a barrel, before slipping back to about $104.5, a 3.3% rise on the day. British gas prices rose to above 203p per therm, the highest since December 2022.

Continental European gas prices also increased. The Dutch wholesale gas price – the EU standard – passed €80 per megawatt hour (MWh) for the first time since January 2023. The front-month contract is trading 3.4% higher at €82.56/MWh.

This, in turn, increased government borrowing costs in leading economies. The interest rate on benchmark 10-year UK government bonds, also known as gilts, hit 5.36%, the highest since August 2007.

The rate on Germany’s 30-year government bond rose 2.5 basis points to 5.08%, the highest since December 2003. The 10-year yield hit 3.45%, the highest since April 2011. France’s 10-year government bond yield was the highest since October 2008 at 4.344%, up 1 basis point.

Central banks are concerned that high fuel and energy prices will feed into higher transport costs and more expensive heating for commercial and residential properties, which will lead to a broad-based rise in inflation.