ECB to review interest rates due to renewed hostilities in Hormuz amid ‘extremely unstable’ outlook

Oil prices are back in the spotlight after several days of strikes between the United States and Iran, creating uncertainty over the European Central Bank’s interest rate decision next week.

Investors on Wednesday were again pricing in the ECB’s July 22 monetary policy meeting, as soaring oil prices cast doubt on hopes of keeping policy unchanged.

“The new outbreak of military conflict in the Middle East and the new rise in oil prices highlight that the situation remains extremely volatile and uncertainty is equally high,” Joachim Nagel, president of Germany’s Bundesbank and ECB rate-setter, told Reuters on Wednesday.

“It is desirable to continue to respond cautiously, but it is also desirable to act decisively when necessary,” he said. “Monetary policy will remain cautious,” he said.

The ECB cut interest rates four times in the first half of 2025, raising the key deposit rate from 3% at the start of the year to 2% by mid-June. But last month, the bank was forced to change its policy, raising interest rates by 25 basis points to the current 2.25%.

The headline inflation rate had been hovering around the ECB’s 2% target before the Iran war broke out, but has since accelerated and reached a peak of 3.2% in May. Initial estimates show that inflation in the euro area slowed to 2.8% last month, as core inflation was capped at 2.4%, even as energy costs rose 8.7% year-on-year last month, suggesting the inflationary effects of the “second round” in other economies are limited.

But energy prices rose again this week as days of hostilities between the United States and Iran over control of the strategic Strait of Hormuz reignited concerns about oil supplies. September futures prices for Brent crude, the international benchmark, rose again early Wednesday morning, above $85 a barrel, after last week at around $70, approaching pre-war levels.

Oil prices are crucial for the eurozone economy, which will import 57% of its energy needs in 2024, according to the latest data available from Eurostat.

But policymakers will be wary that an overly restrictive monetary policy stance could push the eurozone economy into recession after shrinking by 0.2% year-on-year in the first quarter of 2026.

Policymakers will also be aware that initial forecasts for second-quarter GDP growth and July inflation will not be available until July 30 and July 31, respectively. This means next week’s interest rate decisions will be made without access to the latest data.

Michelle Tucker and Benjamin Schroeder, interest rate strategists at ING, said in a note on Wednesday that euro zone inflation data are “crucial in challenging hawkish market positioning”, but “yet these numbers are not enough to reassure markets about the risks of a second round”.

“All of these uncertainties mean that the European Central Bank’s pricing in the market could continue to diverge from the Fed’s pricing,” they said. “Inflation momentum in the US should decline, but in Europe the peak may not yet be in sight, especially if energy prices trend upward again.”

After last month’s drop in oil prices, investors have effectively ruled out the possibility of an ECB rate hike next week, with current market prices still indicating a roughly 20% chance of a rate hike. But investors still expect two more 25 basis point rate hikes by next spring, bringing the ECB’s key deposit rate to 2.75%.

“At the moment we are paying particular attention to the indirect price effects of the Middle East war and possible secondary effects,” Austrian central bank president Martin Kocher told German newspaper Belsen Zeitung on Wednesday. “While we don’t see any impact from the second round at this point, we also need to adjust monetary policy in line with inflation expectations,” he said.