Why we raised rates this week, and Irish GDP in the spotlight

Yesterday, the ECB Governing Council decided to raise interest rates by 0.25 per cent. This first change since June 2025 brings the Deposit Facility Rate to 2.25 per cent.

I supported the decision and, along with my colleagues on the Governing Council, am committed to delivering our 2 per cent inflation target over the medium term.

Let me explain the context for this decision and what it means for the period ahead.

The Inflation Picture

Oil prices have risen sharply on foot of the latest conflict in the Middle East. Energy-intensive products, particularly those produced in the Gulf region, have followed suit. I have previously highlighted fertilisers and helium as prominent examples that could have downstream implications for consumer prices in food and electronic goods (for example, helium is a critical input in semiconductor fabrication).

The flash estimate for euro area headline inflation in May was 3.2 per cent, up from 3 per cent in April and 1.9 per cent in February. Energy inflation alone was close to 11 per cent in May.

Services inflation rose from 3 per cent in April to 3.5 per cent in May. Global supply chain pressures intensified in March and April, pointing to further upward pressure on goods prices in the months ahead. Survey data point to rising input prices and lengthening supplier delivery times and suggest firms expect selling prices to rise over the summer. 

These are not comfortable numbers, and they are moving in the wrong direction. 

Is This 2022 All Over Again?

The two shocks have a similar impetus - both were geopolitical events that pushed up energy prices- but the economic backdrop today is different, and this matters.

In 2022, the energy shock arrived into an economy recovering strongly from the pandemic, with inflation already above 5 per cent, strong demand momentum and tight labour markets. The inflation that followed combined supply disruption with demand pressure. Policy responded strongly with a sequence of rate increases calibrated to cool demand and anchor expectations.

Demand today is below the levels we experienced coming out of the pandemic and, prior to the start of the war, inflation was around our 2 per cent target. Labour demand is also cooler than in 2022, which is also reflected in the easing of wage growth across the euro area. Consumer confidence and business sentiment has fallen. GDP has been revised down, from 1.2 per cent in 2026 in December, to 0.8 per cent in the latest projections.

This weaker economic backdrop matters, because, as the economic literature suggests, the pass-through of oil shocks to consumer prices tends to be weaker in low-inflation or weaker demand environments. This can happen because, in the face of weaker demand, firms find it harder to pass-on extra costs and workers have weaker bargaining power when it comes to wage demands.

While conscious of this backdrop, I am also wary of taking too much comfort from a “this time is different” narrative, for a few reasons. As I already indicated, the incoming hard and soft data shows clear upward price pressures. Another concern I have is the potential for tipping points around oil supply that may not be fully reflected in energy price futures.

I am also keeping a close eye on inflation expectations. We know that at the outbreak of the war in February, euro area consumers revised their short-term inflation expectations upward. We also know that households are encountering this new shock already carrying the memory of the recent post-pandemic inflation surge: before the war, 41 per cent of consumers surveyed said they were still paying close attention to price changes, and this has since risen to 50 per cent. The message I take from this is that this accumulated experience could make them more sensitive to price developments.

What This Decision Means

The decision to increase rates yesterday does not automatically mean we are embarking on a new extended tightening cycle equivalent to what happened in 2022 and 2023. As I have said, the context is different and so the calibration should be different. The rate increase is guided by our commitment to the 2 per cent target and to the principle that supply shocks cannot simply be accommodated when they risk being persistent and near-term inflation expectations are as sensitive as the data suggest.

The path ahead remains genuinely uncertain and, for policy, data-dependent. The eurosystem staff projections released yesterday have headline inflation in the baseline averaging 3.0 per cent in 2026, 2.3 per cent in 2027 and 2.0 per cent in 2028. But given the ongoing uncertainty, a milder (than the baseline), more adverse, and more severe energy price scenario were also considered. The range of inflation under these scenarios is 2.9-4.0 per cent in 2026, 1.8-5.3 per cent in 2027, and 1.8-3.0 per cent in 2028. 

If there is a peaceful and sustainable resolution to the war, supply chains should start to normalise and energy prices ease. In this scenario, policy could adjust. But the longer the conflict persists and the Strait of Hormuz remains closed, the more distant this scenario becomes. So, I remain equally focused on the potential for tipping points, and on indirect and second-round effects. If indirect effects intensify or second-round effects emerge, monetary policy will need to respond.

In short, we will follow the data and do what is necessary to deliver price stability.

Irish GDP in the Spotlight: Understanding the Volatility

One piece of data that has had a bit of coverage recently has been the latest Gross Domestic Product (GDP) figures for Ireland. Understandably, they have attracted significant attention: the dramatic 12.1 per cent quarterly decline caused overall euro area GDP growth in Q1 to be revised down to -0.2 per cent. But as is often the case with Irish GDP, the headline number tells only part of the story, and understanding what lies beneath it is important.

Ireland is a small, open, and highly globalised economy that has become a key export hub for multinational enterprises, most prominently in pharmaceuticals and information technology. The share of our measured economic activity accounted for by foreign-owned multinationals is high, around half of GDP. Trade as a share of GDP, at 230 per cent, is also exceptionally high, compared with the euro area where trade is between 50 per cent and 100 per cent of GDP (depending on whether you include trade outside of the EU or also include trade between Member States).

GDP measures the aggregate volume of production of – and expenditure on – goods and services. This includes activities done within a jurisdiction, but also activities done elsewhere in the globe on behalf of corporate entities resident there. (This calculation is an international standard and based on the UN System of National Accounts.)  In Ireland’s case, for example, an Irish-resident pharmaceutical or ICT company may own raw materials and intellectual property used in the production of a good on their behalf in another country, which is subsequently exported from that other country to the Irish entity's customer.

This is one reason the contribution of exporting multinationals to Irish GDP is so large relative to their contribution to Irish employment, which in itself is quite significant at approximately 12 per cent. The bottom line is that the scale of multinational activity here means that developments in those industries and firms can heavily influence aggregate activity measures such as GDP.

Modified Measures Tell a Different Story

That GDP is not the best measure of domestic economic conditions and inflationary pressures in Ireland is not news. To address this, the Central Statistics Office also publishes modified measures of economic activity that seek to abstract from the hyper-globalised elements in the National Accounts. In particular, Modified Domestic Demand (MDD) is a measure of consumer spending, home building, government spending, and investment by businesses in Ireland in commercial buildings, most types of machinery, software, and some other intangibles. In my view, it is a more useful measure of economic activity in Ireland.

Despite the GDP decline of 12.1 per cent in Q1 2026, MDD rose in the quarter by 0.6 per cent. For the euro area, total GDP contracted by 0.2 per cent including the Irish GDP data. Using MDD for Ireland instead, euro area GDP rose by 0.2 per cent in Q1. This divergence illustrates why we focus on modified measures when assessing domestic economic conditions.

What Happened in Q1?

The GDP decline in Q1 is concentrated in the pharmaceutical sector, and likely in a small number of firms, and there are two elements.

First, during Q1 2025 there was a substantial increase in the exports out of Ireland of a chemical called “polypeptide hormones”. This is a high-value input to the production of medicines for diabetes and weight loss. Most of the growth in Irish goods exports in 2025 came from this.

However, exports of these goods were exceptionally volatile during last year, and we had accounted for how these unusually high volumes could distort growth estimates for 2026 (so-called ‘base effects’). In addition, the available information on demand and inventory levels in key markets suggested relatively weak export activity through most of 2026. Our expectations were partly corroborated by preliminary Q1 GDP data published by the CSO on April 29th, which estimated a quarterly decline of 2 per cent in Q1, or 6 per cent year-on-year. However, even this was marginally weaker than our expectation at the time.

Second, and more of a surprise, was the decline during Q1 in net trade related to offshore goods, specifically merchanting and contract manufacturing activity.¹ Data on these activities, which relate to how multinationals manage the globalised nature of their value chains, are not available at the time of the flash GDP estimate and only became available when the full quarterly national accounts and balance of payments data were published on June 4th.

It is the decline in net trade related to this activity (reflecting production and trade undertaken abroad on behalf of Irish-based companies) that accounted for the substantial drop in Irish GDP during Q1, leading to the large downward revision from -2 per cent in the flash release to -12.1 per cent in the full release.

What does this mean for the Irish and euro area economy?

So, have these Q1 GDP developments changed my perspective of the overall conditions in the Irish and euro area economy relevant to our monetary policy decisions? No, not to any great extent.

Given that industry, and possibly even product-specific, factors were key in the Irish GDP outturn, and that these developments are not a good signal of broader economic conditions in Ireland or the euro area, these factors are not relevant to the fundamental economic drivers of inflation dynamics. To the extent that volatility in the Irish GDP data also influence the euro area aggregate, then this also is relevant when interpreting euro area GDP numbers.

This is why it remains useful to also consider modified measures such as MDD. It is a better measure of broad economic conditions facing households and businesses in Ireland and provides a closer link between that activity and inflationary pressures.

Conclusion

The Governing Council is determined to deliver on its price stability mandate and ensure inflation returns to our 2 per cent target in the medium-term. Our analysis of the evidence persuaded us to raise interest rates yesterday. We are not committing to a pre-determined path and will continue to base our decisions on a meeting-by-meeting and data-dependent approach. At the Central Bank, we will publish our next Quarterly Bulletin on 18 June which will include further analysis on the drivers and implications of the Q1 outturn on the Irish economic outlook.

Gabriel Makhlouf