ECB meeting: On hold as inflation and growth risks pull in opposite Directions
David Kohl, Chief Economist, Julius Baer
The ECB left interest rates unchanged, balancing above-target inflation driven by higher energy prices against tightening financial conditions and weakening growth momentum. While a December rate hike remains possible, slowing economic activity and subdued underlying inflation argue for a prolonged pause in policy rates. The early departure of President Lagarde does little to alter the reaction function of the ECB in 2027.
At its October meeting, the ECB’s Governing Council voted to leave all three key interest rates unchanged. The deposit facility rate remains at 2.50%, the main refinancing rate at 2.65%, and the marginal lending facility rate at 2.90%, in line with economists’ expectations. The decision was somewhat overshadowed by the earlier announcement that President Christine Lagarde will step down from the ECB in February 2027, around eight months before the scheduled end of her term. The upcoming leadership transition adds to the numerous challenges facing the ECB as it seeks to determine the appropriate monetary policy stance. Inflation remains above the ECB’s price stability target, largely due to a surge in energy prices. Measures of underlying inflation, however, are much closer to the 2% target. Wage growth shows few signs of accelerating and appears consistent with achieving the ECB’s inflation objective. Financial conditions have tightened considerably in recent months, initially because of expectations of higher policy rates and subsequently due to concerns about fiscal sustainability and political uncertainty in France. The latter is increasingly weighing on economic activity, thereby reducing the risk that higher energy prices trigger broader second-round inflation effects. We continue to see a possibility that the ECB will refrain from raising policy rates further in the coming meetings, particularly as growth risks continue to mount, credit activity is expected to soften, and bond yields remain elevated. At the same time, another rate hike at the ECB’s December meeting remains a distinct possibility, as policymakers seek to ensure that the energy-driven cost shock remains a temporary inflation phenomenon. We stand ready to adjust our view of unchanged ECB rates should economic data prove stronger than expected and fiscal concerns in France ease more rapidly than anticipated.
