The ECB Is About to Raise Rates for the First Time Since 2023: How the Hormuz Oil Shock Reversed Europe's Monetary Easing

Between June 2024 and June 2025, the European Central Bank cut interest rates eight consecutive times. The deposit facility rate fell from 4.00% to 2.00%, a full 200-basis-point easing that was supposed to mark the end of Europe's post-pandemic inflation fight. Core inflation had fallen below 2%. Manufacturing was in recession. The eurozone economy was growing at barely 1%. The cutting cycle was textbook: inflation normalised, growth weakened, monetary policy eased. By mid-2025, the debate was whether the ECB would cut to 1.75% or even 1.50%.

Then the Strait of Hormuz closed. And in the space of three months, every assumption underpinning European monetary policy was invalidated. Energy prices surged 10.8% year-on-year in April — the sharpest spike since February 2023. Headline inflation jumped from 1.7% in late 2025 to 3.0% in April 2026. GDP growth stalled at 0.1% quarter-on-quarter. And the ECB, which less than a year ago was easing policy as fast as it credibly could, is now expected to hike rates at its June 11 meeting — the first increase in 33 months.

This is the most dramatic monetary policy reversal in the ECB's 26-year history. It is also, depending on how you read the data, either a disciplined response to a genuine inflationary threat or a policy error that risks tipping Europe into its first stagflationary episode since the 1970s.

The Timeline: From 4% to 2% to … Back Up Again

Sources: ECB official rate decisions, Bloomberg, Reuters. Rate market pricing as of May 30, 2026.

The speed of the reversal is what makes it extraordinary. In December 2025, the ECB's own staff projections showed inflation converging to 2% by mid-2026. The debate at that point was whether the neutral rate was 1.75% or 2.00%. Some Governing Council members were openly advocating for further easing. The policy stance was described, in ECB parlance, as “appropriately calibrated.”

Five months later, that assessment looks like a relic from a different economic era. The 2026 Strait of Hormuz crisis — which disrupted approximately 20% of global oil supply and has pushed Brent crude above $120 per barrel — delivered an energy price shock that no amount of forward guidance could have anticipated. European natural gas prices surged 52% between the March and April ECB meetings alone. And because energy feeds into everything from transport to food to industrial inputs, the inflationary impulse is broadening in ways that make the “temporary supply shock” framing increasingly untenable.

The Inflation Picture: Broader Than Just Energy

Sources: Eurostat, ECB staff projections (March 2026), European Commission Spring Forecast. Growth forecasts are full-year 2026.

The headline 3.0% figure understates the problem the ECB faces. Energy prices rose 10.8% year-on-year in April — the sharpest increase since February 2023, when Europe was still adjusting to the loss of Russian pipeline gas. But inflation is no longer confined to energy. Non-energy industrial goods prices accelerated from 0.5% to 0.8%. Unprocessed food inflation rose from 4.2% to 4.6%, as higher energy and fertiliser costs fed through supply chains. Services inflation remained elevated at 3.0%. The only deceleration came from processed food (1.7% to 1.6%), a narrow offset against a broad-based acceleration.

The country-level dispersion adds a layer of complexity. Spain, the eurozone's fastest-growing major economy at 0.6% quarter-on-quarter, also has the highest inflation rate among the Big Four at 3.5%. France, with zero quarterly growth, has the lowest inflation at 2.5% but saw its May flash estimate accelerate to 2.8%. The ECB sets one interest rate for 20 economies with very different inflation dynamics and growth trajectories — a structural challenge that the Hormuz shock has made acutely visible.

Why the ECB Is Leaning Toward Hiking

The April 30 meeting held rates at 2.00%, but the published minutes revealed it was a close call. Several Governing Council members “indicated that they would not have opposed raising rates at the current meeting had this been on the table.” Bank of Italy Governor Fabio Panetta — historically one of the more dovish voices on the Council — struck a hawkish tone, arguing that “the persistence of the Iran war and the risk of further supply disruptions pointed to the need for intervention” and called for “a recalibration of the monetary policy stance.” When the doves start sounding like hawks, the direction of travel is clear.

President Lagarde had already laid the intellectual groundwork. In late March, she stated that “some measured adjustment of policy could be warranted” if a large but not-too-persistent inflation overshoot occurred. The ECB's own language has shifted from describing inflation risks as “balanced” to acknowledging that “upside risks to inflation and the downside risks to growth have intensified.” The institutional mood music is unmistakable: a June hike is the base case.

Markets agree. Rate futures fully price a 25-basis-point hike on June 11, with a second hike expected by September and a 92% probability of a third before year-end. If all three materialise, the deposit rate would reach 2.75% by December — erasing more than a third of the easing delivered over the previous 18 months. A Bloomberg survey of economists published May 11 aligned with this consensus: two hikes in 2026, with the balance of risks tilted toward more.

The Stagflation Dilemma

The case against hiking is straightforward: you do not tighten monetary policy into an economy growing at 0.1%. The eurozone added almost no output in Q1 2026. Germany — the bloc's largest economy — halved its 2026 growth forecast from 1.0% to 0.5% in April, after two consecutive years of contraction. Exports are projected to stagnate for a fourth consecutive year. The ifo Institute estimates that US tariffs alone will reduce German GDP growth by 0.6 percentage points in 2026. France delivered zero quarterly growth while simultaneously tightening fiscal policy to address a deficit that exceeded 5% of GDP in 2024. The periphery — Italy with 138.6% debt-to-GDP, Greece at 137.6% — faces higher borrowing costs at exactly the moment fiscal room is narrowing.

Hiking into this environment risks what economists call a “policy error of the second kind” — treating a supply-side shock as if it were demand-driven inflation. The textbook response to a supply shock is to accommodate the first-round price effects and only tighten if second-round effects (wage-price spirals, unanchored expectations) emerge. The ECB navigated exactly this dilemma during the 2022–2023 energy crisis triggered by Russia's invasion of Ukraine, eventually hiking to 4% as core inflation proved sticky. But in 2022, the economy was still growing above trend. In 2026, it is not.

The case for hiking rests on credibility. If energy prices remain elevated for long enough, they cease to be a “temporary shock” and become embedded in expectations. The ECB's own staff projects headline inflation averaging 2.6% for 2026 — above target — and explicitly warns that “as the period of high energy prices extends, the likely impact on broader inflation through indirect and second-round effects intensifies.” Eurozone wage negotiations in key sectors are ongoing, and there are early signs that energy-driven cost increases are being passed into services prices. The risk of doing nothing is that the ECB loses the credibility it spent 2022–2023 rebuilding.

How Europe's Economies Are Diverging

Spain is the outlier. Its economy grew 0.6% quarter-on-quarter in Q1, or 2.7% year-on-year — more than triple the eurozone average. Spain's growth is driven by tourism (record arrivals in 2025), immigration-fuelled labour force expansion, and a less energy-intensive industrial base relative to Germany. But Spain also has the highest inflation among the Big Four at 3.5%, creating the paradox where the eurozone's strongest economy is partly the reason the ECB needs to hike, while its weakest economies will bear the heaviest cost.

Germany's predicament is structural, not merely cyclical. Its growth model — export-oriented manufacturing powered by cheap Russian gas — has been disrupted twice in four years: first by the loss of Russian energy, now by the Hormuz crisis that has driven replacement LNG prices to levels that make energy-intensive industry uncompetitive globally. Exports contracted for three years in a row before the Hormuz shock added tariff uncertainty on top of energy costs. The $500 billion defence and infrastructure spending package passed by the new coalition is a medium-term boost, but its effects on GDP are projected to begin only in 2027–2028. In the near term, Germany is essentially subsidising the eurozone's credibility while absorbing the largest economic cost.

France's zero growth in Q1 is partly self-inflicted. The government's fiscal consolidation programme — triggered by a deficit that reached 5.5% of GDP in 2024, well above the EU's 3% ceiling — is withdrawing demand at precisely the wrong moment. S&P Global Ratings projects French growth at 0.7% for 2026, noting that “global shock leaves recovery uncertain.” Italy's position is more precarious: 138.6% debt-to-GDP means that every 25-basis-point rate hike costs the Italian treasury approximately €3–4 billion in additional annual interest payments as debt rolls over. The ECB's Transmission Protection Instrument exists to prevent a repeat of the 2012 sovereign debt crisis, but the existence of a backstop does not eliminate the fiscal pain of tighter policy.

The Global Context: A Central Banking Divergence

Sources: ECB, Federal Reserve, Norges Bank, RBNZ, SNB, Bank of England. Rates and inflation as of latest available data (April–May 2026).

The Federal Reserve held rates at 3.50–3.75% in April, but the 8–4 vote — the first time four officials dissented since October 1992 — signals deep internal disagreement. The transition from Jerome Powell to Kevin Warsh as Chair adds another variable; Warsh is expected to take a more hawkish stance. Norway, as profiled in our Norway economy analysis, is already hiking because petroleum wealth creates domestic demand pressure that standard monetary policy models struggle to address. Switzerland sits at the opposite extreme: 0% rates, 0.6% inflation, and a safe-haven franc that absorbs imported energy price increases through currency appreciation.

The divergence matters because it creates currency effects that amplify or dampen inflation. A weaker euro against the dollar — which rate differentials make more likely if the Fed holds while the ECB hikes modestly — would increase the cost of dollar-denominated oil imports, partially offsetting the inflation-fighting effect of higher interest rates. The ECB is well aware of this dynamic; it was one of the arguments against aggressive easing in late 2025, when euro depreciation threatened to import US inflation. In 2026, the mechanism works in reverse: a modest hike that does not close the transatlantic rate gap may strengthen the euro just enough to help, but not enough to resolve the underlying energy cost problem.

What Comes After June

If the ECB hikes 25 basis points on June 11, the question immediately shifts to: how far does this go? The market-implied path — two to three hikes totalling 50–75 basis points by year-end — would take the deposit rate to 2.50–2.75%. That is still well below the 4% peak of September 2023, but it is enough to meaningfully tighten financial conditions for an economy growing below 1%.

The trajectory depends almost entirely on one variable: how long the Hormuz disruption lasts. If oil flows normalise by Q3 — a scenario that requires either a ceasefire or successful military de-escalation — energy prices would retreat, headline inflation would fall toward 2% by early 2027, and the ECB could reverse the hike or pause after one. If the disruption persists through year-end, as the joint IMF/IEA/WB/WTO statement of May 28 warns is possible, second-round effects become unavoidable. Wage settlements embed higher energy costs. Corporate pricing power shifts. Inflation expectations de-anchor. In that scenario, the ECB would be forced into a hiking cycle that it explicitly does not want, tightening into an economy that may already be in technical recession in multiple member states.

There is a dark irony in the ECB's position. It spent 2022–2023 hiking rates to defeat inflation caused by one energy shock (the loss of Russian gas). It spent 2024–2025 cutting rates to support an economy weakened by the aftermath. And now it faces a second energy shock that demands the same medicine, administered to a weaker patient. The eurozone's structural vulnerability to energy supply disruptions — a consequence of geography, geology, and decades of insufficient investment in energy independence — means that monetary policy is perpetually hostage to geopolitical events in regions the ECB has no influence over.

For the 350 million people who live in the eurozone, the practical implications are concrete. Mortgage rates will rise. Corporate borrowing costs will increase. Government debt service will consume a larger share of national budgets, reducing fiscal space for investment and social spending. And the economy will grow more slowly than it otherwise would have. Whether these costs are justified — the price of maintaining the ECB's inflation-fighting credibility — or excessive — the price of fighting a supply shock with demand-side tools — is the central question of European economic policy in 2026. The answer will not be clear for years. But the first hike in 33 months is now less than two weeks away.

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