On the twenty-fifth of March, speaking at the ECB's annual conference on monetary policy implementation in Frankfurt, President Christine Lagarde used a phrase that had not appeared in her public remarks since the autumn of 2022: she said the Governing Council stood ready to raise interest rates. The context was a question about the inflationary consequences of the war between the United States and Iran, which has sent Brent crude above $120 per barrel and disrupted energy supplies to a degree not seen since Russia's invasion of Ukraine four years ago. Her exact formulation was that a "large, though not-too-persistent, overshoot" of the ECB's inflation target could warrant "some measured adjustment of policy" [1]. In the careful, hedged idiom of central bank communication, this was as close to a warning shot as the institution permits itself. The ECB, she was saying, would not be "paralysed by hesitation" [2].

The significance of this statement cannot be appreciated without recalling the velocity and direction of the journey that preceded it. Between July 2022 and September 2023, the ECB raised its deposit facility rate from zero to 4.0 per cent, the most aggressive tightening cycle in the institution's twenty-seven-year history, undertaken in response to an inflation surge that peaked at 10.6 per cent in October 2022 [3]. Then, beginning in June 2024, the Governing Council reversed course with a sequence of eight cuts that brought the deposit rate to 2.0 per cent by March 2026 [4]. The easing cycle was, by the standards of the ECB, remarkably swift: a cumulative 200 basis points of reduction in nine months. The logic was sound at the time. Headline inflation had fallen below 2 per cent by late 2025. The eurozone economy, while not in recession, was growing slowly enough to justify monetary support. The staff projections published in December 2025 forecast inflation of 1.9 per cent for 2026. The war has made that forecast obsolete.

Fig. 1

The ECB Deposit Facility Rate, January 2022 to March 2026

From zero to 4.0 per cent, then back to 2.0 per cent in less than four years. No central bank of comparable stature has compressed a full policy cycle into so short a period.

Source: European Central Bank. Monthly data points; rate shown is effective at month end.

The revised staff projections published on 19 March now forecast headline inflation of 2.6 per cent for 2026, up from 1.9 per cent only three months earlier [5]. The revision is almost entirely attributable to energy prices. The war, which began in late February with American and Israeli strikes on Iranian nuclear facilities, escalated rapidly when Iran imposed a partial blockade of the Strait of Hormuz, through which roughly one fifth of the world's traded oil passes daily. Brent crude, which had been trading in the low eighties at the start of the year, surged to $120 per barrel by mid-March and has remained elevated. The International Energy Agency described the disruption as among the most severe since the 1970s [6]. For the ECB, the question is whether this energy shock will feed through into core inflation, as it did in 2022, or whether it will remain confined to headline figures and dissipate as the geopolitical situation evolves.

Lagarde's remarks on the twenty-fifth suggest that the Governing Council is not waiting to find out. She noted, with a candour that her predecessors would have found uncomfortable, that European businesses may be "quicker to raise prices" this time because of the bitter memory of the 2022 inflation episode [1]. This is the second-round effect that central bankers most fear: the expectation of inflation becoming self-fulfilling as firms pass through energy costs pre-emptively and workers demand compensating wage increases. The ECB's own survey of professional forecasters, conducted in February, showed five-year inflation expectations rising to 2.1 per cent, a modest number in absolute terms but the highest reading since 2023, and precisely the kind of de-anchoring signal that makes monetary policymakers anxious.

The Precedent That Is Not a Precedent

The closest historical analogue is the Federal Reserve's experience in 1998 and 1999. The Fed, under Alan Greenspan, cut the federal funds rate by 75 basis points in the autumn of 1998 in response to the Long-Term Capital Management crisis and the contagion from the Asian financial crisis, then reversed course and raised rates by 175 basis points between June 1999 and May 2000. That reversal, however, took place over a period in which the American economy was growing at nearly 5 per cent annually and the dot-com bubble was inflating asset prices to levels that made the case for tightening straightforward. The ECB's situation is more fraught. The eurozone is not growing at 5 per cent; the latest estimate for Q4 2025 was 0.9 per cent annualised. The case for tightening rests not on domestic overheating but on an exogenous supply shock, which is precisely the kind of disturbance that conventional monetary theory says central banks should "look through" rather than respond to with interest rate adjustments.

The difficulty with the "look through" prescription, as the ECB learned in 2021 and 2022, is that it depends on inflation expectations remaining anchored while the shock passes. The ECB initially described the post-Ukraine inflation as "transitory," a word that Lagarde herself used in a press conference in December 2021, only to spend the following eighteen months chasing inflation upward with progressively larger rate increases. The institutional memory of that sequence is, one may reasonably suppose, a significant factor in the Governing Council's current posture. Having been too slow once, the Council would rather err on the side of pre-emption than endure a repetition of the credibility damage sustained in 2022.

Governing Council member Peter Kazimir stated publicly in March that policymakers might need to move "earlier than markets had anticipated" [4]. His fellow board member Isabel Schnabel, who has been the most intellectually rigorous voice on the Council regarding the transmission of energy shocks, wrote in a February blog post that the "asymmetry of risks" had shifted: the cost of being too slow to tighten, if inflation becomes entrenched, is considerably greater than the cost of being too quick, if the shock proves temporary [5]. This is the Brainard principle in reverse, and its invocation signals a genuine shift in the Council's risk calculus.

What the Markets Are Pricing

As of 25 March, overnight index swap markets were pricing approximately a 35 per cent probability of a 25 basis point rate increase by July, up from effectively zero at the start of the year. The two-year German Schatz yield has risen by 28 basis points since the conflict began, reflecting a recalibration of the rate path. But the market pricing remains cautious, and for good reason: most private-sector forecasters still expect the ECB to hold rates through 2026, on the view that the energy shock will prove temporary and that the underlying disinflationary forces in the eurozone economy, ageing demographics, weak productivity growth, and tight fiscal policy in several member states, will reassert themselves once the geopolitical premium in oil prices dissipates [4].

The dissenting view, which is gaining adherents, holds that the structure of the current shock is different from 2022 in ways that make a rate response more likely, not less. In 2022, Europe had diversified energy options: it could, and did, pivot away from Russian gas toward LNG, renewables, and demand destruction. The Strait of Hormuz disruption affects global oil supply at a choke point for which there is no ready substitute. Even if the conflict reaches a negotiated resolution, as the Trump administration has intermittently suggested, the insurance premium embedded in energy prices may persist for months or years. Moreover, the eurozone economy, while not robust, is in considerably better condition than it was in the winter of 2022, when a recession appeared imminent. The unemployment rate stands at 6.2 per cent, the lowest in the common currency's history. Lagarde herself noted that the backdrop is more "benign" than in 2022 [1], which is simultaneously a reassurance and an argument for having the policy space to tighten if needed.

The Institutional Question

There is a deeper issue at stake, one that transcends the immediate policy decision. The ECB is a young institution, barely a generation old, and it has spent most of its existence in extraordinary circumstances: the global financial crisis, the eurozone sovereign debt crisis, the pandemic, and now a second major energy shock within four years. It has not yet established the kind of institutional rhythm that the Federal Reserve developed over its first century, the predictable alternation of tightening and easing cycles that allows markets and the real economy to calibrate expectations. If the ECB were to raise rates in the second half of 2026, having cut them through the first quarter, it would be the first time the institution had reversed direction within the same calendar year. The signal this would send about the stability and predictability of European monetary policy is not trivial, particularly at a moment when the euro's role as a reserve currency is the subject of renewed debate.

What Lagarde is attempting, one suspects, is a form of verbal pre-emption: by signalling readiness to tighten, she hopes to influence expectations and forestall the very second-round effects that would make actual tightening necessary. This is the Draghi playbook, the "whatever it takes" approach applied in reverse. Draghi's genius in 2012 was to convince markets that the ECB would act, thereby reducing the need to act. Lagarde may be attempting the same manoeuvre with inflation: by convincing firms and wage-setters that the ECB will not tolerate a persistent overshoot, she may dampen the very pass-through effects she described. Whether this will succeed depends on whether the credibility of the commitment is believed, and credibility, in central banking as in life, is a function of demonstrated willingness to follow through. The Governing Council has not yet raised rates. Until it does, the signal remains verbal. And the history of verbal signals from central banks that were never acted upon is long enough to counsel scepticism.

The months ahead will test the ECB's institutional character in a manner it has not been tested before. The question is not simply whether to raise rates; it is whether the institution can execute a policy reversal of this velocity without undermining the forward guidance framework on which it has staked much of its communication strategy. The answer will tell us something important, not merely about the ECB's response to the current crisis, but about the maturity of the institution itself.

References

1. Lagarde, C. "ECB ready to hike rates even if expected inflation surge is short-lived." Reported by CNBC. 25 March 2026. cnbc.com
2. "ECB Won't Be 'Paralyzed by Hesitation' on Iran, Lagarde Says." Bloomberg. 25 March 2026. bloomberg.com
3. European Central Bank. "Monetary Policy Decisions and Key ECB Interest Rates." ECB Statistical Data Warehouse. Accessed March 2026. ecb.europa.eu
4. "ECB Expected to Hold Rates Through 2026, but War-Driven Energy Shock Boosts Hike Odds." Prism News. March 2026. prismnews.com
5. European Central Bank. "Eurosystem Staff Macroeconomic Projections for the Euro Area, March 2026." ECB. 19 March 2026. ecb.europa.eu
6. "Iran war energy shock puts ECB on alert." Euronews. 25 March 2026. euronews.com
7. "Europe's top central banker thinks businesses may be quicker to raise prices due to Iran war." Associated Press. 25 March 2026. usnews.com