- The European Central Bank has raised its deposit rate by 25 basis points to 2.5% after eurozone inflation reached 3.3% in August.
- UK borrowing costs rose in parallel, with ten-year gilt yields hitting 5.378% and 30-year yields approaching 6%.
- The combination of expensive energy and expensive capital presents a particular problem for renewables, nuclear power, networks and other infrastructure-heavy parts of the transition.
Europe’s energy shock is developing into a financing shock after the European Central Bank raised interest rates and UK government borrowing costs reached levels last seen before the financial crisis.
The ECB increased its deposit rate from 2.25% to 2.5% on Thursday, its second rise this year, as higher oil and gas prices pushed eurozone inflation to 3.3%. The bank now expects inflation to average 3% in 2026 and 2.5% next year, delaying a return to its 2% target until late 2027.
Its published rates show the deposit, refinancing and marginal lending facilities moving to 2.5%, 2.65% and 2.9% respectively from 16 September.
The decision followed renewed disruption to Middle Eastern energy supplies, with Brent crude moving above $105 a barrel and European gas prices also climbing. ECB president Christine Lagarde warned that further supply disruption could keep energy prices higher for longer, although cooling wage growth and underlying inflation may limit the extent of future tightening.
The immediate UK significance lies in the bond market. The benchmark ten-year gilt yield rose ten basis points to 5.378% on Thursday, its highest since July 2007. 20-year and 30-year yields reached 5.895% and 5.948%, the highest since 1998.
Two-year and five-year yields, which are more sensitive to monetary policy expectations, rose to 4.87% and 4.95% respectively. The move was attributed to energy price inflation, renewed attacks on Middle Eastern shipping and strong US economic data.
Challenge for capital-intensive energy
The Bank of England is still expected to leave Bank Rate at 3.75% on 17 September. Nevertheless, markets were pricing a 97% probability of an increase in November after the gilt sell-off.
That matters well beyond conventional monetary policy. Government bond yields provide the reference rate against which investors price infrastructure debt and equity. When that rate rises, projects with high upfront costs and returns spread over several decades become harder to finance.
Offshore wind, electricity networks, nuclear plants, carbon capture and hydrogen are particularly exposed. Contracted revenues through mechanisms such as Contracts for Difference can reduce wholesale price risk, but they do not eliminate construction costs, refinancing exposure or the higher return expected by investors when low-risk government debt offers nearly 6%.
The Treasury faces the same pressure. Britain sold £4.25 billion of 30-year gilts on Tuesday at an average yield of 5.8168%, the highest at a government debt sale since comparable records began in 1998. The transaction drew £87.2 billion of orders, demonstrating that buyers remain available, but only at a much higher price.
The emerging contradiction is stark. High fossil fuel prices strengthen the strategic case for domestically produced low-carbon energy, but the resulting inflation and rate rises make that infrastructure more expensive to build. Unless government support prices and regulatory settlements adjust to the new cost of capital, the energy shock could slow investment in the assets intended to reduce exposure to the next one.
