ECB: Rates on hold, debate heats up

[Ben Graham]

• The ECB is widely expected to keep interest rates unchanged at next week’s meeting, with markets fully pricing a stable deposit rate.
• New inflation projections may intensify internal debate, showing inflation below target in 2026–27 but above target in 2028 due to regulatory factors.
• Diverging views within the Governing Council reflect a split between calls for early rate cuts and arguments for patience amid economic resilience.
• A hawkish tone from President Lagarde could further support EUR/USD, potentially pushing the pair toward the 1.19 level.

The European Central Bank is widely expected to leave interest rates unchanged at next week’s meeting. Year-end positioning points to policy stability rather than surprise: financial markets have been pricing the deposit rate at 2.0% for weeks, and among institutions surveyed by Bloomberg, only one anticipates a rate cut in December. In that sense, the immediate policy outcome appears largely predetermined.

However, a lack of action should not be mistaken for a lack of tension. The meeting is likely to be internally contentious, reflecting diverging views within the Governing Council on the inflation outlook and the balance of risks around it.

New projections rekindle the inflation debate

The ECB’s updated macroeconomic projections, due to be published next week, are set to play a central role in the discussion. A key technical adjustment stems from the postponement of the EU’s ETS 2 carbon pricing system from 2027 to 2028. As a result, inflation projections are likely to shift meaningfully across the forecast horizon.

Inflation for 2027 is expected to be revised down by around 0.2 percentage points to roughly 1.7%, clearly below the ECB’s 2% target. In contrast, the 2028 inflation forecast is likely to be revised above target, reflecting the delayed impact of the ETS 2 framework. This profile - undershooting first, overshooting later - creates fertile ground for disagreement within the Council.

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The main interest rate in the euro area, CPI inflation measures, and the Composite PMI index (euro area), source: Bloomberg.

Doves vs. hawks: competing policy narratives

Those arguing in favour of earlier rate cuts are likely to emphasise that inflation is projected to remain well below target in 2026–27, justifying a pre-emptive easing of monetary policy. They may also downplay the relevance of the higher 2028 inflation forecast, stressing the high degree of uncertainty inherent in projections so far into the future.

Conversely, opponents of rate cuts can point out that temporary deviations from the inflation target are acceptable, particularly when driven by one-off regulatory factors rather than underlying demand pressures. From this perspective, patience remains the appropriate stance.

Economic resilience strengthens the case for caution

Another argument supporting a steady policy stance is the relatively robust macroeconomic backdrop. There is broad consensus within the Governing Council that, despite multiple headwinds, the euro area economy has shown notable resilience. Growth in 2025 is widely seen as exceeding 1%, with the outlook for subsequent years remaining constructive. Such conditions do little to ease inflationary pressures and weaken the case for near-term rate cuts.

Implications for EUR/USD: hawkish tone could fuel further gains

In the currency market, EUR/USD has been trending steadily higher, and levels around 1.19 appear increasingly attainable before year-end. Should President Lagarde strike a clearly hawkish tone at the press conference, euro strength could be driven not only by ongoing US dollar weakness, but also by renewed confidence in the ECB’s commitment to maintaining restrictive policy for longer.

Overall, while next week’s ECB meeting is unlikely to deliver a policy move, it may still prove pivotal in shaping expectations for the timing and pace of future easing — and in determining whether the euro’s upward momentum can be sustained.

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EUR/USD exchange rate chart, daily data, source: TradingView

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