ECB Review: Firmly frozen policy

• The ECB left its policy rates and guidance unchanged, as expected, and maintained the “meeting by meeting” and data-dependent stance. The updated projections were hawkish with headline and core inflation revised higher after signs of more persistent pay pressures. Services inflation is expected to remain elevated across the horizon, which offsets the significance of the projected undershoot in headline rates. Growth was also revised higher, as expected. Lagarde acknowledged uncertainty but did not push back against recent market repricing away from cuts. With rates at neutral and inflation hovering around target, the bar for policy adjustment – in either direction – is high. We expect rates to remain unchanged in 2026.

• We have removed our forecast for one final 25 bps ECB rate cut in 2026. However, it remains premature for the euro-zone rates market to price in hikes as early as next year, given that inflation is still expected to undershoot the ECB’s target. Euro-zone rates have already moved higher recently as markets priced out further ECB cuts, providing additional support for the euro. With the BoE and the Fed still expected to lower rates further next year, we forecast continued EUR strength in 2026 while the ECB keeps its policy rate on hold.

Macro view: Policy in hibernation for the winter and beyond

The bar for policy adjustment, in either direction, is high

The ECB left policy unchanged, as expected, in a unanimous decision. Rates are at neutral, inflation is within a whisker of target and there have been no game-changing data surprises since the last policy meeting. Against that background it was unsurprising to hear the familiar ‘good place’ theme reiterated by Lagarde. The core guidance (“data-dependent”, “meeting-by-meeting” and without any pre-commitment to a particular rate path) was left unchanged.

There was more action in the updated projections. Headline inflation was revised up to 1.9% in 2026, from 1.7% in September, and remains below target until 2028. The core number was revised from 1.9% to 2.2%. We expected an upward revision to the core numbers (see our preview here), but to a smaller extent. The ECB has responded forcefully to the surprise on Q3 compensation per employee growth (4.0% vs ECB expectations for 3.2%) by raising its assumptions for 2026 by 0.5pp, to 3.2%. In turn, projected services inflation has been lifted to 3.0% and is expected to remain elevated across the horizon (2.5% in 2028) despite the assumption that pay pressures will moderate to levels consistent with target by the end of next year. This is clearly hawkish and offsets the significance of the expected sub-target headline inflation. Without the boost to energy prices from the expansion of the EU’s emissions trading system, the ECB is projecting undershooting inflation across its projection horizon, but officials will point to sticky services inflation when challenged on this.

The ECB also revised up its growth outlook, as had been flagged by Lagarde earlier this month. It now sees growth at 1.2% in 2026, in line with our views, and 1.4% in 2027-28. Lagarde sounded more confident about the outlook in the press conference and mentioned a boost to activity from stronger private investment (especially related to AI) and the lack of any clear tariff frontloading reversal effects.

Against this background, there wasn’t any pushback from Lagarde against recent hawkish market repricing away from the possibility of cuts next year, beyond highlighting that uncertainty remains high. The ECB won’t provide forward guidance and will continue to stress the meeting-by-meeting approach. But policymakers are clearly content with how well-anchored expectations are for rates to remain at their current levels next year. Comments and projections today further reinforced that.

All told, the bar for policy adjustment, in either direction, is high. We still think that the disinflation process could be bolstered next year (we expect headline inflation to average 1.7% vs the ECB’s latest figure of 1.9%). Lower energy pricing should support this. The cut-off date for the ECB’s projections came before the move lower in oil pricing, and there are further downside risks to prices from other factors e.g. further EUR strength and trade diversion. But it likely would take a significant and sustained undershoot on inflation combined with weaker wage pressures to test the ECB’s resolve and prompt a calibration lower. Policy looks set to remain firmly in hibernation mode through the winter and beyond. We see rates unchanged through 2026.

A hawkish shift in the ECB’s HICP projections

Lower energy pricing poses an immediate downside risk

Markets view: Longer ECB hold to support stronger EUR

Updated staff forecast sets higher hurdle for another ECB rate cut

The euro initially strengthened against the U.S. dollar following today’s ECB policy update and the release of the softer U.S. CPI report for November. These developments lifted EUR/USD to an intraday high of 1.1763, up from around 1.1710 prior to the ECB’s policy announcement. In contrast, the euro weakened against the pound, reflecting the bigger hawkish policy surprise delivered by the Bank of England. EUR/GBP fell to an intraday low of 0.8735 after trading closer to 0.8775 before the BoE’s update.

The euro has been supported by upward revisions to the ECB staff’s growth and inflation forecasts for the euro area. These updates have given the ECB greater confidence that policy is in a “good place,” although President Lagarde reiterated that all options remain on the table and that future decisions will follow a data-dependent, meeting-by-meeting approach. The revised forecasts suggest a higher hurdle for additional rate cuts, but the ECB was not yet ready to formally declare an end to the easing cycle. That could come soon though. A Bloomberg report released just after today’s policy meeting has since revealed that officials believe the rate cut cycle is most likely over absent another major shock. On the other  hand, the report added that any talk of rate increases was seen as premature. President Lagarde refrained from providing encouragement today that the next move is more likely to be a hike than a cut.

Further rate cuts would require a more pronounced inflation undershoot in 2026 and 2027. Beyond another negative shock, downside risks to the inflation outlook include a stronger euro and lower oil prices. The ECB’s latest projections assume EUR/USD at 1.1600 in the coming years and oil prices around USD 63 per barrel. Taking recent developments into consideration, we have removed our forecast for one final 25 bps cut next year and now expect the ECB to keep rates on hold. At the same time we still expect the Fed will deliver multiple rate cuts next year in response to a loosening U.S. labour market conditions. Unlike the Fed, the ECB’s policy rate is already closer to estimates of the neutral level. The narrowing of yield differentials supports our forecast for EUR/USD to climb back above 1.2000 in 2026.

EUR RESUMES UPWARD TRENDS VS. GBP & USD HEADING INTO 2026

Source: Bloomberg, Macrobond & MUFG GMR