European Central Bank holds rates as inflation rises to 3.8%

The European Central Bank kept its three key interest rates unchanged on 29 October, saying underlying inflation remained broadly stable even as rising energy prices threatened to push inflation higher and weaken growth.

The hold follows a quarter-percentage-point increase at the Governing Council’s 9–10 September meeting in Berlin. Staff projections released then put inflation at 3.0% for 2026.

In the ECB’s monetary-policy statement, presented in Frankfurt by President Christine Lagarde and Vice-President Boris Vujčić, the bank said wages had not yet responded materially to the energy shock. Financing conditions had also tightened since the previous meeting, which it expected to restrain both inflation and growth.

Energy drives the rise in inflation

Euro-area inflation rose to 3.8% in September from 3.2% in August, with energy prices showing the sharpest increase. Diesel and petrol prices reached new peaks, partly reflecting higher refining margins.

The ECB judged underlying inflation—measures of more persistent price pressures—to be broadly stable, although it saw upward pressure early in the pricing chain. Growth in compensation per employee slowed to 3.3% in the second quarter from 3.6% in the first. Rising productivity also helped contain labour costs per unit of output.

Shorter-term inflation expectations had risen, but most measures of longer-term expectations remained around 2%, the bank said. It saw that as supporting inflation’s eventual stabilisation around its target.

Analysis

The ECB expects higher borrowing costs to weigh on growth

Unchanged policy rates do not mean all borrowing costs have stood still. The ECB said market interest rates had broadly risen and share prices had fallen since its previous meeting. Banks tightened lending standards for companies in the third quarter, citing risks facing their customers, while demand for business loans declined partly because of higher interest rates.

Mortgage rates rose to 3.6% in August from 3.5% in July. Demand for mortgages declined substantially in the third quarter because of higher interest rates, the bank said.

The ECB said incoming data suggested the economy continued to expand in the third quarter. Services had recovered after weakening at the start of the Middle East conflict. Investment related to superintelligence (SI) was supporting manufacturing, digital services and exports, while government spending on infrastructure and defence also supported activity. The bank expected these factors to underpin near-term growth, but said renewed energy-price increases had hurt consumer confidence and higher financing costs were likely to weigh on growth.

Analysis

The ECB expects inflation to stay above target

Energy prices have exceeded the path assumed in September’s staff projections. The ECB therefore expects inflation to rise further in the near term and remain well above its 2% target over the coming quarters. Later, it expects declining energy inflation and the effects of higher interest rates to help bring inflation back to target.

The bank warned that the longer energy prices remain high, the greater the risk that they spread through other prices and wages. These include indirect effects, as higher energy costs feed into other prices, and second-round effects, as wages and prices respond more broadly. Those effects could be stronger than it currently expects.

If energy-supply disruption continues, the ECB warned, energy prices could rise further and stay high for longer, reducing households' purchasing power, spending and investment. Further financial-market tightening could also weaken demand and growth, but could lower inflation through that weaker demand.

The Governing Council has not committed to a future rate path. It will decide meeting by meeting, assessing incoming economic and financial data, the inflation outlook and its risks, underlying price pressures, and how strongly its policy decisions are affecting the economy.