The ECB is set to raise interest rates this week; economists warn it may repeat the policy mistake of 2011.

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The European Central Bank is set to hold a policy meeting this week, and the market widely expects an interest rate hike will be announced. However, multiple economists have issued warnings: as the eurozone economy shows signs of weakness and US-Iran peace talks continue, the ECB’s eagerness to defend its anti-inflation credibility may be repeating the policy mistakes of 2011.

According to a Bloomberg report on Monday, since the outbreak of the US-Iran conflict, ECB officials had previously held their ground, but now are clearly inclined to raise rates to prevent a spike in energy prices from triggering broader inflation. The latest inflation rate in the eurozone has risen to 3.2%, with core inflation pressures also moving up notably, and both corporate and household inflation expectations remain high. Last week, hawkish ECB Executive Board member Isabel Schnabel warned that “the risk of inflation expectations becoming unanchored is increasing.”

However, some economists argue that raising interest rates prematurely, before there is concrete evidence of second-round inflation effects, may not only deliver unnecessary tightening shocks to the already burdened eurozone economy, but may also lead markets to interpret this move as the start of a rate hike cycle, thus undermining the ECB’s policy flexibility. This concern points directly to the history lesson of 2011—when the ECB twice raised rates before the deepening of the European debt crisis, only to be forced to reverse course entirely soon after.

The Ghost of 2011: History’s Lessons Reappear

The policy mistake of 2011 is at the heart of the current debate. That year, under then-ECB President Jean-Claude Trichet, the central bank raised borrowing costs twice, citing the same concerns over inflation driven by surging commodity and energy prices. Yet, policymakers underestimated the vulnerability of the eurozone’s financial system. When successor Mario Draghi took over at the end of the year, he quickly turned to rate cuts, and the eurozone ultimately slipped into a double-dip recession.

TS Lombard economist Davide Oneglia put it bluntly: “The ECB seems determined to prove its credibility. The rate hikes of 2011 were a clear policy mistake, and with the ECB now fixated on inflation expectations and deeply scarred by the lessons of 2022, repeating past mistakes is one of the greatest risks we face.”

An earlier example from 2008 offers a similar warning. The ECB raised rates in July of that year, only for the collapse of Lehman Brothers a few months later to force a rapid reversal. Societe Generale Chief Economist Michala Marcussen remarked, “When the ECB opts to raise rates without firm evidence of second-round inflation effects, it is incurring unnecessary tightening risks.”

The Logic of the Rate Hike Camp: Credibility Must Not Be Shaken

Officials and economists who support rate hikes have their reasons. Inflation in the eurozone has reached 3.2% and is expected to accelerate further; core inflation, excluding energy and food, has also moved up significantly; and both business pricing plans and household inflation expectations remain high.

From hawkish Schnabel to dovish Greek Central Bank Governor Yannis Stournaras, several officials have indicated that the ECB can no longer turn a blind eye to energy shocks and must uphold its commitment to keeping inflation at the 2% target.

The lessons from 2021–2022 are equally sobering. The Russia-Ukraine conflict hit energy markets hard, driving eurozone inflation to a historic peak of 10.6%. Even though the ECB subsequently took unprecedented tightening actions, there remains widespread criticism that it acted too late. Former ECB Chief Economist Peter Praet commented, “At some point, you have to show the willingness to act.”

Bank of Finland Governor Olli Rehn described the likely action this week as a “preventive rate hike.” Praet likened it to a “warning shot to show you mean business,” but also emphasized that it is crucial not to signal that “this is the first step of a series of rate hikes.”

Economic Weakness, Doubts About Room for Further Rate Hikes

Another key argument from the opposing camp is the actual state of the eurozone economy. Business activity in the region is shrinking at its fastest pace since the start of 2024, with France’s economy particularly weak. Earlier this year, overall eurozone growth turned negative due to a large downward revision of Irish data; even excluding Ireland, growth was only a minimal 0.2% to 0.3%.

Berenberg Chief Economist Holger Schmieding believes that tightening policy would impose an unnecessary burden on households and businesses, while inflationary pressure may subside naturally due to economic weakness. He stated, “Given that consumers are already in difficulty, there’s no need to raise rates,” and considering the many obstacles facing demand, “a temporary uptick in prices is unlikely to become persistent inflation requiring rate hikes.”

PGIM’s Chief European Economist Katharine Neiss told Bloomberg she expects the ECB to complete this rate hike with a “dovish tone” and keep room for policy reversals—“If the economy really starts worsening as survey data indicate, they will cut rates, and do so in a way that does not harm their credibility.”

Market Expectations: Two Rate Hikes This Year, Possible Rate Cuts Next Year

Currently, the consensus among investors and economists is for two rate hikes this year, each by 25 basis points, in line with ECB President Lagarde’s description of a “measured adjustment” in response to “larger but temporary” inflation overshoots. At the same time, markets expect at least one rate cut as early as mid-2027.

Morgan Stanley Chief European Economist—and former ECB economist—Jens Eisenschmidt predicts the ECB will complete two rate hikes in the coming months and reverse all of them next year. He argues this should not be viewed as a policy mistake: “Acting in June to address above-target inflation and rising price expectations is likely a carefully considered decision amid uncertainty; likewise, a rate cut a year later is probably based on judgment that restrictive policy is no longer needed.”

However, not everyone is convinced by this logic. At the heart of the debate is the question: amid ongoing US-Iran peace talks and still-uncertain energy shocks, should the ECB give itself more time to assess the situation, rather than rush to raise rates to assert its credibility—for after all, history has shown that acting too soon can carry a far heavier cost than waiting.

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