The European Central Bank (ECB) decided to keep its key interest rate unchanged at 2.25% on Thursday, citing ongoing uncertainty over the impact of volatile energy prices on inflation in the eurozone. This marks a pause following a quarter-point increase in June, the first rate hike since oil prices surged after the outbreak of conflict between the United States and Iran in late February.

ECB President Christine Lagarde emphasized that the central bank is closely monitoring the situation, noting that the inflationary effects of the energy shock have yet to fully materialize. "The longer energy prices stay high, the more likely they are to drive up broader inflation through indirect and second-round effects," she said during a post-decision news conference. Lagarde also highlighted that the bank is making decisions on a meeting-by-meeting basis, without committing to a predetermined path for future rate changes.

The initial June increase from 2% to 2.25% came as a response to higher oil costs driven by the U.S.-Iran conflict and the disruption of oil shipments through the strategic Strait of Hormuz. Crude oil prices have been particularly volatile in recent weeks, briefly falling after the announcement of a ceasefire agreement, only to spike again following its collapse and the expansion of hostilities involving Yemen’s Iran-backed Houthi rebels and attacks on Saudi oil tankers in the Red Sea. Brent crude reached $100 per barrel on Thursday, its highest level in two months.

While inflation in the eurozone eased slightly from 3.2% in May to 2.8% in June, it remains above the ECB’s 2% target, and the central bank has warned that inflation pressures may intensify. The eurozone economy faces a delicate balance, with some ECB governing council members reportedly advocating for further rate increases in response to the renewed energy price surge, although the latest decision was unanimous in holding rates steady.

Market participants widely anticipate the possibility of at least two more rate hikes before the end of the year, possibly beginning with the ECB’s next policy meeting on September 10. However, beyond that, uncertainty remains high. Economists point to the interplay between high energy costs and the region’s relatively weak economic growth and labor market, which could limit sustained inflationary effects.

The recent oil price developments have also pushed borrowing costs higher for eurozone governments, with yields on German 10-year bonds reaching a decade-high of 3.2%. The euro held steady against the U.S. dollar at around $1.14 but saw a slight decline against the British pound. European stock markets closed lower amid the increased volatility, with Germany’s DAX, Italy’s FTSE MIB, and France’s CAC 40 all slipping.

Overall, the ECB remains vigilant as it seeks to balance the risks of rising inflation driven by external energy shocks against the potential dampening effect of its monetary policy on economic growth. The central bank’s future decisions will largely depend on how the energy situation evolves and its broader impact on eurozone inflation and economic conditions.