ECB Review: Firmly frozen policy

• Macro view: The ECB remains firmly on hold, leaving its policy rates and guidance unchanged as expected at today’s meeting. Lagarde played down the fall in inflation in January and stressed that the ECB will not overreact to single data points. The expectation remains that inflation will stabilise around target over the medium term. The familiar ‘good place’ motto was trotted out again as officials continue to make it abundantly clear that they are happy with the current policy setting. While we maintain our view that a cut is more likely than a hike this year, the hurdles for any policy calibration are obviously high. Our base case is for unchanged rates (and more low-key meetings) this year.

• Markets view: The ECB’s guidance to leave rates on hold remains supportive for the EUR while the Fed plans to lower rates further. The recent pick-up in US political uncertainty helped to boost the relative appeal of the EUR lifting EUR/USD briefly above 1.2000 before President Trump chose to nominate Kevin Warsh as the next Fed Chair. President Lagarde highlighted that the exchange rate was important to consider in decision making, but did not push back strongly against recent strength.

Macro view: Policy remains in hibernation

The ECB can tolerate undershooting inflation

Today’s ECB policy decision was another low-key affair. The ECB left its rates and guidance unchanged at its first policy meeting of 2026, as fully expected, and repeated its all-too-familiar ‘good place’ mantra.

That narrative had looked marginally shakier in recent weeks given geopolitical volatility and FX strength, but the ECB highlighted the resilience of the economy in a “challenging global environment” (we broadly agree with this) and Lagarde played down the significance of recent euro strength, as discussed below. 

The ECB president also emphasised that the slide in headline euro area inflation in January, to 1.7%, is tolerable. She said that the ECB will not be “hostage” to single data points and stressed that inflation is expected to stabilise around target over the medium term.

In short, officials continue to make it abundantly clear that they are happy with the current policy setting and are not especially bothered by sub-target inflation at the start of the year.

The monetary rationale behind this is certainly fair – rates are at the ECB’s central estimate of neutral and inflation has been well-behaved for an extended period now. We suspect there is also a secondary ambition to provide both stability and reassurance that the crisis years are in the rear-view mirror.

The disinflation process could yet be bolstered by euro strength or trade diversion, and the recent rise in energy prices may well prove temporary. A sustained period of inflation at around 1.5%, say, would certainly be a communication challenge and could test officials’ resolve. In that case we think a policy calibration downward to 1.75% (still within the ECB’s estimated range of ‘neutral’) is plausible, provided that underlying inflation pressures ease further and economic growth does not exceed potential rates.

On activity, it's worth noting that, despite the upside surprise in Q4 growth (0.3% Q/Q), PMI data has softened at the start of this year and weak retail sales in December suggest little momentum on the consumer side.

But clearly the hurdles for any policy calibration remain high. Our base case is for unchanged rates (and more low-key meetings) this year. 

Euro area inflation dipped lower in January but continues to hover around target

The PMIs suggest weaker momentum outside of Germany at the start of the year

Markets view: : ECB hold & stronger growth are tailwinds for EUR

ECB refrains from pushing back forcefully against stronger EUR

The EUR has strengthened initially following today’s ECB policy meeting. EUR/USD briefly moved back above 1.1800, while EUR/GBP has risen above 0.8700. The euro found support after the ECB reiterated that both its policy stance and the inflation outlook are “in a good place.” President Lagarde noted that nothing has materially changed the underlying inflation baseline.

At the same time, the ECB acknowledged in its opening statement that “the gradual rollout of public spending on defence and infrastructure” is helping to support growth, alongside low unemployment, solid private‑sector balance sheets, and the lagged effects of previous rate cuts. Adding to the more positive tone for the euro, the latest German factory orders report for December released this morning offered further encouraging signs of an improving industrial sector. Factory orders surged by 7.8% for the second consecutive month—marking the strongest two‑month gain since the initial post‑COVID reopening in mid‑2020.

US dollar weakness at the start of this year helped lift EUR/USD briefly above 1.2000 at the end of last month. The stronger euro drew increased attention from President Lagarde at today’s press conference, although she refrained from pushing back forcefully against it. She acknowledged that the trade environment has become more challenging due to higher tariffs and the euro’s appreciation. She also recognised that a stronger euro could push inflation further below the ECB’s target.

Lagarde noted that the exchange rate was discussed at today’s meeting, given its importance for both the growth and inflation outlook, and emphasised that the ECB would continue to monitor it closely. However, she also stressed that the moves in the euro since last March were already incorporated into the ECB’s baseline scenario, adding that the current trading range against the USD is “very much in line with average.” This signals that the ECB is not overly concerned about the euro’s strength at current levels.

However, if the euro continues to appreciate as we expect this year lifting EUR/USD toward 1.2500, it would increase pressure on the ECB to lower rates further especially with inflation already projected to undershoot target. This is one reason why we judge that risks to our forecast (click here) for the ECB to leave rates on hold this year remain skewed to the downside.

EUR strength attracts more attention after rising above 1.2000

Source: Bloomberg, Macrobond & MUFG GMR