It is not a question of whether it was right, but whether it will be "almost right" when Europe's central bank makes its 25-basis-point rate hike today.

Europe's energy bill wasn't merely skyrocketing when the Middle East went up in flames, it went off the charts. The euro zone's headline inflation rate rose to 3.2% in April, driven primarily by a 10.9% gain in energy prices. Just that should stop anyone else saying that the European Central Bank could sit on its hands much longer. It didn't today, June 11. Investors had been looking for the ECB to hike its key rates by 25 basis points (bps), while at least one more increase was built into the year-end outlook.

The increase was announced weeks ago. Not clearly, anyway, what wasn't telegraphed is what happens next. That's not the drama going on in Frankfurt's Eurotower that's about today's 25-point move. It's a central bank in between two mighty forces pulling in the opposite directions: an inflation shock it cannot ignore and a growth slowdown it cannot afford to worsen.

The journey towards this development has begun in February, during a time when energy prices were in fact in negative territory (declining at a 3.1% annual rate) and headline inflation was comfortably below the ECB's 2% target (1.9%). Then there was the Iran war. The annual inflation rate in the eurozone jumped to 2.5% in March, from 1.9% in February, while consumer prices increased by 1.2% month-over-month, the highest since October 2022. It was that one blip a month that made all the difference.

The euro zone imports about 55% of its energy requirements for comparison. It lacks any significant domestic oil reserves, has very few natural gas reserves, and has a manufacturing sector that relies in part on energy intensive processes, especially in Germany. Rising oil prices for Brent crude and high gas prices for TTF gas have a first and foremost impact on households and factories in Europe. Inflationary pressure will remain high, as will the pressure on the purchasing power of households, the margins of businesses and industrial activities, with Brent oil at around $110 per barrel and Dutch TTF gas at about €50/MWh.

A "stagflation trap" no one dared to mention.

Stagflation is the term that central bankers dread using, as it gives them no choices. And yet here it is. According to Berenberg's chief economist, Holger Schmieding, Europe's three largest economies, Germany, France and Italy, have been hit by the recent surge in energy prices and the continent is currently in a stagflationary environment of higher inflation and unemployment and lower growth.

The statistics support his claim. In its annual forecasts, the ECB lowered its forecast for GDP growth in 2026 to just 0.9%, below previous estimates, while at the same time increasing its inflation forecasts, especially for this year, due to an increase in energy prices following the Middle East war. A central bank that is experiencing both above-target inflation and sub-1% growth has nearly all dirty options on the table.When Reuters asked 80 economists about their expectations for the June 11 meeting, 74 predicted the ECB would hike its deposit rate to 2.25%, compared with 59 of 70 economists in May. What is more striking, however, is the fact that 49 of 80 now expect two more rate hikes in 2026, and of those surveyed, 28 of 42 believe the risk of stagflation this year is high.

Let's pause there for a second to contemplate that last data point. As for the single most dangerous economic conditions that the zone is facing today, more than two-thirds of the surveyed economists think it's the combination of sluggish growth and continued inflation, a condition that monetary tightening will make somewhat better, perhaps a lot worse.

What hawks want, doves fear;

In the Governing Council the fault lines are firmly drawn. On the other side are the inflation hawks, such as ECB policy-maker Joachim Nagel, who have said that a rate hike would be needed to maintain the bank's credibility should price pressures continue. On the other hand, the doves are gambling on the consequences of a materially higher cost of borrowing when demand is already slowing down, and on German industrial production, French consumer confidence and Italian sovereign debt service.

The internal tension is reflected in the minutes of the meeting in April. Some ECB members said that the April decision not to raise rates was a close one and they would have voted to do so if it had been put to them. The energy-led supply shock is proving more lasting than anticipated, said policymakers, raising the likelihood of more widespread and entrenched inflationary pressures.

ECB staff are likely to downgrade their growth forecasts for 2026-27 and upgrade their headline and core inflation forecasts, as the energy shock seems more permanent and its indirect impacts to prices have increased, wrote Goldman Sachs chief European economist Sven Jari Stehn in a note. An indicator he uses in his own bank indicates that prices for energy have risen about 12% since March alone. This constant repricing can't stop in the pump but will spread through logistics, manufacturing inputs, food supply chain, and, importantly, consumer expectations.

The second-round effects argument

Now the case for hiking becomes stronger and more troubling at the same time. Core inflation also ticked up to 2.5% in April, with the increase mainly stemming from an increase in costs for services, something that is especially worrying for the ECB as this type of inflation is more home-grown and less likely to turn around on its own following an external price shock.

An increase in energy prices is the first shock to the household. Then comes the second round: workers demand larger wages to make up for a drop in their real income, businesses jack up service prices to offset of course, and soon enough what began as an outside hit on the economy from a hike in energy prices becomes built into the economy's price structure. That's what Frankfurt is trying to avoid.

The most significant number to watch will be the ECB's core inflation forecast for 2027, as it will give an indication of how confident policymakers are that second-round effects will not take hold, Société Générale senior European economist Anatoli Annenkov said.

There are already some early signs of unanchoring in inflation expectations. The euro zone's consumer inflation outlook jumped to 43.4 in March from 25.8 in February, marking the biggest monthly increase in years, data from the European Commission showed. ING's global head of macro Carsten Brzeski had previously suggested that markets were going too far and had pointed to three reasons for the ECB to act: an annual inflation rate above 4%, a core inflation rate above 3% and an uptick in inflation expectations as measured in surveys. As of his last note, none of those thresholds had been broken, but he admitted that the “expectation” threshold was very near.

The market has partially already done the work.

A bizarre aspect of this episode is that even financial markets, by pricing in the rate hike in advance of today's actual decision, have tightened conditions a bit. Giving effect to the tighter policy is already happening as market expectations of imminent monetary tightening are creating more "restrictive financial conditions and lending conditions," Goldman Sachs European economist Alexandre Stott said.

Schmieding's parallel point is that the inflationary effects of the rise in energy costs should start to die down on their own as consumers adjust to higher energy bills by cutting their spending on discretionary goods – in theory, that shouldn't require as much monetary tightening as it does otherwise. While an intellectually credible argument, it also has a rather brutal sub-text: that the path to lower inflation may be through a recession, not through policy.

No one can model the Strait of Hormuz variable,

Geopolitical uncertainty reigns at the centre of it all, and is something no econometric model can adequately deal with. The IMF data indicates that maritime traffic in the Strait of Hormuz is still highly restricted, at more than 90% below the year ago level. That's not a "sideline disturbance". It is a nearly complete closure of one of the world's most important energy choke points and not just for crude oil.

In the coming months, there could be further upward pressure on food prices due to the disruptions of food supply chains, as a result of the reduced maritime activity through the Strait, including potential shortages in fertilizers. The inflation in food prices had already started to increase to 2.5% in April. If supply chains are broken, as they may be through the summer planting, that number could shift significantly upward by the fall, just when a new round of ECB deliberations would be taking place.

Bloomberg's survey indicated that the quarter-point rate hike that's anticipated today will likely be the last one, but most economists still don't see a long-term price shock coming from the Iran crisis. The optimism of that view is likely misplaced. The euro area GDP forecast was reduced from a projected 1.2% growth in the fourth quarter of this year to 0.8% in response to the situation, Vanguard's senior economist had earlier said, when oil prices averaged $90-100 per barrel for one to two quarters, and warned that risks were tilted toward increases, especially if energy prices increased further or if the conflict turned out to still be long.

Beyond Frankfurt what this means.

It's important to pause and reflect on the implications of the ECB's situation for the wider system of the global economy in 2026. This is a situation that leaves the euro zone with a structural weakness: an overreliance on imports of energy commodities, in a world where geopolitical risk has become unpredictable. The bloc was not entirely sheltered from another shock, as the transition away from Russian gas after 2022 did bring some changes, such as more LNG terminals and renewables capacity, but not enough.

In the meantime, the ECB has a comparison that they would much rather not be faced with but one that they have no way to avoid. The Feds have a "dual mandate" of price stability and maximum employment, which provides them with political cover to balance competing concerns. The ECB has one single mandate keeping inflation close to its 2% target and this implies that when numbers are created that impair this, the ECB has less room to argue for patience. It is built to tighten and the numbers are telling it to do so even as the growth numbers counter.

The ECB itself explicitly identified this tension in its April statement: “Upside risks to inflation and downside risks to growth have both increased, the Governing Council said, noting that the longer the war continues and the higher energy prices stay, the greater the impact on the general level of inflation and on the economy would be.” It's a very honest admission that this bank is in trouble no matter what direction it takes.

One hike is not a strategy

What the move does on June 25, the equivalent of a quarter-point rate increase, is to buy some credibility. It is a warning that the ECB isn't prepared to allow inflation expectations to be permanently changed upward by an externally caused energy shock. That is relevant as several ECB officials contributed that despite the two rate hike forecasts this year, inflation would still be slightly above the bank's target. One hike then is hardly that.

What Frankfurt requires, and what markets are starting to require, is a coherent framework for dealing with a world where oil and gas prices are tied to geopolitical events in a part of the world where there is no resolution in sight. That framework doesn't exist yet. The reality is a meeting-by-meeting, data-driven strategy that proved fairly effective when the shocks were transitory and the economy was in good health. Both are no longer true today.

The euro zone started 2026 with a lot going right: Inflation hit target; wage growth slowed; and the ECB was cautiously hopeful. The Governing Council had observed that the economic activity had demonstrated resilience over past few quarters' and that the inflation expectations remained well anchored over the longer term. This situation appears to be a "new normal" that has left those conditions behind. Rather than an index of strength, the bank is raising its rates out of a necessity to keep pace with a price spiral, even as it deals with a slowdown in growth, and will be driven to take further action if a war continues until its next policy meeting.