ECB policy and the Euro

Eurozone stable but fragile expansion

Eurozone economy is showing signs of durability rather than dynamism. Output growth is expected to remain modest, with full-year GDP expansion projected near 1.2%, reflecting an economy that has absorbed past shocks but has not yet regained strong momentum. Consumer spending has improved as real incomes stabilize, while investment remains cautious amid lingering uncertainty and tight financial conditions.

The recovery remains uneven across member states. Service-oriented economies have benefited from resilient demand, while manufacturing-heavy regions continue to struggle with weak global trade and subdued industrial activity. Looking ahead, the outlook depends heavily on financial conditions and external demand. Without a meaningful pickup in productivity or exports, growth is likely to remain constrained, reinforcing a low-growth equilibrium rather than a cyclical upswing.

For the euro, this environment reduces recession risk but offers limited upside. Currency performance is increasingly tied to relative monetary policy expectations rather than domestic growth acceleration.

Inflation achieved but risk still present

Price pressures in the Eurozone have eased significantly compared with the inflation surge earlier in the decade. Recent data show consumer price growth hovering around 2.4% nearly the ECB’s 2% objective, with projections pointing to a mild undershoot toward 1.7–1.8% in the early months of 2026. This progress reflects falling energy costs, easing supply chains, and a stronger exchange rate that has lowered imported inflation.

However, underlying inflation dynamics remain mixed. While goods prices have cooled, services inflation remains elevated, supported by firm wage growth and still-tight labor markets. This split suggests that inflation has slowed, but the process is not complete. Any renewed rise in wages or energy prices could slow or reverse recent progress, particularly if demand remains resilient.

As a result, inflation is no longer the primary constraint on policy, but it is not yet a closed chapter. The ECB continues to monitor whether inflation will stabilize sustainably near target or drift lower as restrictive policy works through the economy.

Source: EUROSTAT

ECB strategy for 2026

ECB is expected to maintain a steady policy stance into early 2026, with the deposit rate unchanged at approximately 2.15% since June 5, 2025. Policymakers appear comfortable allowing the effects of earlier tightening to continue working through the economy, rather than moving quickly toward additional easing. With headline inflation near target but services inflation still elevated, the central bank’s priority has shifted from aggressive inflation control to avoiding policy errors that could destabilize either prices or growth.

Based on current data, the most likely scenario is an extended policy pause through at least the first half of 2026. Inflation projections in the 1.7–1.9% range, combined with modest GDP growth near 1%, argue against both rate hikes and rapid easing. A rate cut becomes more probable only if incoming data show a sustained inflation undershoot toward 1.5% or a sharper deterioration in labor markets and domestic demand. Conversely, renewed wage pressure or a rebound in energy prices would likely delay any ease and reinforce the current neutral stance.

Source: European Central Bank