Europe’s Central Banks Halt Rate Cuts as Energy Shock Rekindles Inflation Fears

Europe’s central banks hit pause as war-driven energy shock revives inflation fears

Europe’s two most important central banks left interest rates unchanged on Thursday, underscoring how a renewed energy shock tied to the war in the Middle East has upended expectations that borrowing costs might soon begin to fall again.

The European Central Bank kept its benchmark deposit rate at 2 percent, while the Bank of England held its key rate at 3.75 percent in an 8-to-1 vote. In separate decisions, both institutions pointed to the same uncomfortable reality: inflation risks are rising again even as economic growth remains weak.

That combination — higher prices, softer demand and deep uncertainty over energy markets — leaves policymakers confronting what Bank of England Governor Andrew Bailey described as the “most difficult combination” of economic effects.

The problem is especially acute in Europe, where economies remain highly sensitive to swings in oil and gas prices. What had been shaping up as a steadier phase for monetary policy has been unsettled by the latest jump in energy costs, prompting officials to warn that inflation could stay elevated for longer than they had hoped.

Inflation rises as growth stalls

Fresh data released the same day highlighted the bind.

Inflation in the euro area accelerated to 3 percent in April from 2.6 percent in March, driven in large part by energy prices, which were up 10.9 percent from a year earlier. At the same time, the euro-zone economy barely expanded in the first quarter, growing just 0.1 percent.

For central bankers, that is close to the worst of both worlds. Higher energy prices lift headline inflation quickly, squeezing households and businesses, while also acting as a tax on growth by raising costs and dampening confidence.

The ECB said the conflict in the Middle East had intensified both upside risks to inflation and downside risks to growth. It warned that energy costs were likely to keep inflation “well above 2 percent in the near term” and signaled concern that a prolonged shock could spill beyond fuel bills into wages and broader pricing behavior.

That threat of so-called second-round effects — in which workers seek higher pay and companies pass along higher costs more broadly — is precisely what central banks are trying to avoid. Once that process takes hold, inflation becomes harder to bring back down.

The Bank of England struck a similar note. Officials said prospects for global energy prices were now “highly uncertain” and that the path of policy would depend on how large, long-lasting and broadly transmitted the shock proves to be. At the same time, the bank acknowledged that domestic demand is weak and that the labor market has been loosening, reasons it was not prepared to tighten policy immediately.

A shift in the outlook for rates

Until recently, investors had increasingly focused on when Europe’s central banks might resume easing. The ECB has kept rates unchanged since June 2025, after an earlier phase of cuts brought the deposit rate to 2 percent. The Bank of England lowered rates to 3.75 percent in December 2025 and has been on hold since.

But Thursday’s decisions made clear that any further rate cuts have become harder to justify in the near term. If the energy shock fades, policymakers may still eventually be able to lower borrowing costs. If it persists, further tightening is back on the table.

That is why the latest inflation figures are so consequential. While underlying euro-area inflation excluding energy and food eased to 2.2 percent — a sign that domestic price pressures had been moderating before the latest shock — the rebound in headline inflation complicates the picture. Central banks can often look through temporary jumps in energy costs, but not if they begin to alter inflation expectations or wage-setting behavior.

The ECB said it expected to have much more information by its June meeting, effectively marking the next major checkpoint for investors trying to judge whether the current hold turns into a longer pause or something more forceful.

Markets look for signs the shock may ease

In financial markets, the initial reaction reflected that uncertainty. European stocks recovered from earlier losses later in the day as oil prices eased, a sign that investors remain highly sensitive to any indication that the energy shock may prove less severe than feared.

Still, the rebound did little to change the larger message from policymakers: Europe is once again navigating a supply-driven inflation shock, the kind that monetary policy can do little to prevent and can only respond to imperfectly.

Raise rates too aggressively, and already-fragile economies risk sliding closer to stagnation. Cut too soon, and central banks could allow another burst of inflation to become embedded.

For households and companies, the consequences are immediate. Mortgage and business borrowing costs are likely to stay higher for longer. Energy bills may rise again. And real incomes, already strained by years of inflation, could come under renewed pressure.

That is why Thursday’s decisions mattered beyond the technical details of rate setting. They were a reminder that Europe’s inflation battle, which had appeared to be moving into a calmer phase, has been jolted back into uncertainty by war, commodity markets and the lingering vulnerability of an economy still struggling to regain momentum.