European Central Bank Raises Key Interest Rate to Record High

FRANKFURT—The European Central Bank raised interest rates by a quarter percentage point to a record high but signalled that eurozone borrowing costs may have peaked, sending the euro tumbling.

In a split decision, ECB officials raised the bank’s deposit rate to 4%, the 10th increase in a row and a vertiginous rise from below zero last year.

At a news conference, ECB President Christine Lagarde signalled that Thursday’s rate increase might be the last, although she didn’t rule out further hikes if economic data disappoint.

ECB officials judge that rates “have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution” to reducing inflation to their 2% target, Lagarde said, repeating language used in the bank’s policy statement.

The comment prompted investors to downgrade their expectations for future ECB rates, sending the euro down by almost a cent against the dollar to below $1.07, its lowest level since March. Bond yields slid, with yields on the benchmark 10-year government bonds of Germany, France and Italy down between 0.05 and 0.10 percentage point. European stocks rallied, with the benchmark Stoxx Europe 600 index rising more than 1%.

The eurozone still has lower interest rates than the U.S., as well as higher inflation and a struggling economy that contrasts with relatively healthy economic growth in the U.S.—all factors that are weighing on the euro.

“In all likelihood the ECB is done,” said Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management in Geneva.

Major central banks including the Federal Reserve are signalling a possible halt to a historic series of interest-rate increases over the past 18 months aimed at tackling a surge in inflation unseen since the 1970s.

Ending rate increases would favour borrowers amid uncertainty in the global economy, declining international trade and faltering industrial output. However, signalling a peak in interest rates now risks letting excessive inflation on both sides of the Atlantic become entrenched. Some central banks, including those of Australia and Canada, signalled a pause in recent months, only to start raising rates again.

Recent market movements suggest investors are now betting that rates will peak and even start falling as early as next spring as inflation and economic growth both come down.

They expect the ECB to hold interest rates at about 4% through next summer before starting to cut them, according to data from Refinitiv. They think the Fed will hold rates steady in a range between 5.25% and 5.5% at its meeting next week, and to start cutting rates early next year. The Bank of England is expected to increase interest rates at least once more this year before cutting them later next year.

Investors had been unusually divided before Thursday’s decision over whether the ECB would pause already or unveil one last rate increase. That disagreement reflects uncertainty over how much a slowdown in eurozone growth, together with the ECB’s past rate increases, will cool the region’s inflation rate, which stood at 5.3% in August, unchanged from a month earlier.

Lagarde said some of the central bank’s governors would have preferred to hold rates steady at this month’s meeting. However, a “solid majority” of them agreed on the decision to take rates higher, she said.

New economic forecasts published by the ECB Thursday suggested that eurozone growth will slow significantly more than previously expected this year and next, while inflation will remain markedly above the ECB’s target of 2% through next year. The bank raised its forecast for inflation next year from 3% to 3.2%, mainly to reflect “a higher path for energy prices.”

Asked about the prospect of rate cuts, Lagarde replied that “is not even a word we have pronounced.”

“The longer they can keep interest rates at elevated levels, the more insurance they buy against a downturn down the road,” said Robert Dishner, a senior portfolio manager at Neuberger Berman. “If they end up cutting too soon, they risk reigniting inflation.”

Central banks in Europe face a particularly daunting challenge because while recent interest rate rises have weighed heavily on lending and probably lowered economic growth, they have yet to show a marked effect on underlying inflation. This contrasts with the U.S., where the Fed has taken interest rates higher than the ECB and underlying inflation has fallen significantly while the nation’s growth remains robust. Underlying inflation in August was 5.3% in the eurozone and 4.3% in the U.S.

Recent data and business surveys signal a darkening economic outlook for Europe amid weak growth in China and a decline in global manufacturing. The eurozone economy has largely stagnated since late last year, and industrial production declined in July, dragged down by weakness in Germany, the region’s largest economy.

Lagarde warned that Europe is currently going through a phase of very sluggish growth and suggested that the ECB’s rate hikes are filtering through to the economy. “We are beginning to see weakness in the volume of hires particularly in the services sector that is related to manufacturing,” she said.

Meanwhile, a recent increase in oil prices is pushing inflation in the wrong direction. The euro has slumped against the dollar in recent weeks, to around $1.07 from $1.12 in July, as the eurozone’s economic prospects have soured. That increases the cost of imported goods, making the ECB’s job harder.

Matthew Ryan, head of market strategy at financial-services firm Ebury, said the ECB would likely start cutting rates later, and possibly at a more gradual pace, than the Fed, which should support the euro.

Some of the economic weakening is as intended. The ECB expects its rate increases to slow the region’s economy by weighing on asset prices and demand for loans. However, it isn’t clear if inflation is starting to fall because of the ECB’s actions or because of other factors, such as the fact natural-gas prices are dramatically lower compared with last year, when Russia throttled Europe’s gas supplies. This makes it hard to predict if the region’s economic slowdown will push inflation all the way down to 2%.

Market confidence in the ECB’s ability to achieve its objectives is gradually eroding, with the closely watched five-year, five-year inflation swap—a gauge of expected inflation over a 10-year horizon—standing at 2.6%, according to Franck Dixmier, global chief investment officer for fixed income at Allianz Global Investors.

High current and expected future inflation could mean that investors are underestimating the potential for further ECB rate increases, Dixmier said.

A sharp technology sell-off has exposed a new anxiety on global markets: whether the enormous borrowing behind the artificial-intelligence infrastructure boom can generate sufficient returns as interest rates rise and Chinese competition intensifies.

The artificial-intelligence investment boom has powered technology shares, semiconductor manufacturers and data-centre operators to extraordinary heights. Last week, investors were given a reminder that much of this expansion is being built with borrowed money.

The technology-heavy Nasdaq Composite fell 4.5 per cent over the week ended October 16, its weakest performance since late June. Semiconductor shares suffered an even deeper correction, with the Philadelphia Semiconductor Index losing about 11.4 per cent.

The selling spread quickly through global markets. Micron Technology fell 14.6 per cent over the week, while South Korea’s Samsung Electronics and SK Hynix dropped approximately 18 per cent and 24 per cent respectively.

This was more than a routine bout of profit-taking. Investors were reassessing three interconnected risks: higher interest rates, the rapidly expanding debt burden attached to AI infrastructure and the prospect of stronger competition from Chinese memory-chip manufacturers.

The debt behind the AI build-out

Artificial intelligence requires a physical infrastructure network of enormous scale. Data centres must be built, advanced processors purchased, power supplies secured and cooling systems installed before customers begin generating meaningful revenue from them.

Technology companies are increasingly supplementing their own cash with corporate bonds, syndicated loans, equipment leases, private credit and project-level financing.

JPMorgan describes the emerging funding model as a combination of conventional corporate borrowing and project finance tied to individual data-centre assets. In Australia, the Reserve Bank estimates that syndicated loans accounted for approximately three-quarters of data-centre financing during 2025 and 2026 to date.

The numbers are becoming large enough to affect broader credit markets. The Federal Reserve Bank of Dallas has cited Wall Street estimates suggesting AI-related investment-grade bond issuance could approach US$300 billion in 2026 alone.

That borrowing is not automatically problematic. Debt can be an efficient way to finance long-lived infrastructure when future revenue is sufficiently predictable. The concern is that AI technology, customer demand and computing economics are changing much faster than the repayment schedules attached to the assets.

A data centre financed today may carry debt for years. Investors must therefore make assumptions about future utilisation rates, electricity prices, chip performance, customer concentration and the amount businesses will ultimately pay for AI computing.

When interest rates rise, those assumptions become less forgiving.

Inflation changes the calculation

September’s US inflation data intensified the pressure. Consumer prices increased 3.7 per cent over the year, ahead of market expectations and up from 3.4 per cent in August.

The hotter reading reduced confidence that interest rates would fall quickly and pushed bond yields higher. That matters particularly for companies whose valuations depend on profits expected well into the future, as well as highly leveraged infrastructure operators that may need to refinance.

CoreWeave has emerged as a closely watched test case. The specialist cloud-computing company has accumulated substantial debt and lease obligations to build AI capacity, while relying on a concentrated group of large technology customers.

Its shares fell sharply during the sell-off, while the cost of insuring its debt against default climbed. CoreWeave has argued that its contracted backlog more than covers its obligations and that financial markets do not always understand its business model. Nevertheless, its securities have become a proxy for investor confidence in debt-funded AI infrastructure.

Oracle, another major investor in AI computing capacity, fell 8.8 per cent in Friday trading, while CoreWeave dropped 15.5 per cent.

The question is shifting from how much AI infrastructure can be built to how profitably it can be operated.

China adds another source of pressure

Interest rates were not the only catalyst. Reports of advances by Chinese memory-chip producer ChangXin Memory Technologies raised concerns that lower-cost Chinese products could increase competition across the global semiconductor industry.

Memory chips are essential to AI systems, but the industry is historically cyclical. Periods of tight supply and high pricing can encourage rapid investment, eventually producing oversupply and falling margins.

The prospect of a well-funded Chinese competitor expanding its technological capabilities unsettled investors in Samsung, SK Hynix and Micron. It also demonstrated that AI-related demand does not insulate chipmakers from conventional competitive pressures.

That combination—slower rate cuts, more expensive financing and potentially cheaper supply—challenged the assumption that every company exposed to AI would enjoy continually expanding margins.

A reset rather than the end of the boom

The sell-off does not establish that the AI boom is ending. Demand for computing power remains strong, the largest technology companies continue to generate formidable cash flows and many infrastructure projects are backed by long-term customer contracts.

What has changed is the market’s willingness to overlook the price and financing structure of that growth.

The most resilient companies are likely to be those able to fund investment from operating cash flow, secure long-duration customers and demonstrate that new capacity will earn returns comfortably above its financing costs.

More speculative operators may face greater scrutiny, particularly where debt is expensive, customers are concentrated or expected revenue depends on demand that has not yet materialised.

For Australian investors, the lesson extends beyond US technology shares. Local data-centre operators, infrastructure funds, electricity suppliers and property groups are increasingly exposed to the same investment cycle.

Artificial intelligence may remain one of the defining growth themes of the decade. But last week’s correction showed that enthusiasm for the technology does not eliminate financial discipline.

The next stage of the AI boom will be judged not only by computing power, model performance or demand for chips, but by something more traditional: whether the assets being financed can generate enough cash to repay the money borrowed to build them.

Fact box

Nasdaq Composite: Down 4.5 per cent for the week ended October 16, 2026

Philadelphia Semiconductor Index: Down approximately 11.4 per cent

Micron Technology: Down approximately 14.6 per cent

Samsung Electronics: Down approximately 18 per cent

SK Hynix: Down approximately 24 per cent

US September inflation: 3.7 per cent annually

Estimated 2026 AI-related investment-grade issuance: Approximately US$300 billion