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The European Central Bank (ECB) held rates at 2% this month – and for its third consecutive meeting – as it continues in wait-and-see mode. Indeed, the eurozone’s inflation outlook is little changed. Headline inflation remains close to 2% and the economy continued to eke out growth in Q3, despite the headwinds from US tariffs. The question going forward is whether fiscal stimulus from Germany’s increased defence spending will offset the impact of US tariffs. Until the answer becomes clear, the ECB will probably keep interest rates on hold. However, when the next move eventually comes, we think it’ll be downwards.
ECB to keep interest rates on hold for the foreseeable?
The ECB voted to hold interest rates at 2% at its meeting today as the Governing Council continues to balance steady growth with inflation that remains close to 2%.
This morning’s news that the eurozone managed to grow at an above-expectation 0.2% in Q3 should reassure the ECB further stimulus from monetary policy isn’t urgently needed as the economy continued to grow, despite the stagnation in Germany.
What’s more, inflation has remained within 0.2ppts of the ECB’s 2% target since March as price pressures stabilise. That will also help the ECB to confirm it’s reached a good place with rates around neutral.
Ultimately, we see little reason for the ECB to hurry into further rate cuts.
Risks tilted towards further ECB rate cuts next year
That said, there are a few reasons why we think the risks could favour more rate cuts.
First, US tariffs will drag on growth going forward. Even if the deal with the US helped to bring a degree of certainty around trade, we think this is likely to weigh on exports and investment for the rest of the year.
The bigger impact is likely to come from the euro, which has appreciated by 6.3% so far this year. A stronger euro will make eurozone exports more expensive to trading partners. This, alongside cheaper goods being rerouted into the eurozone because of tariffs on China, will continue to weigh on inflation going forward by making imports cheaper. This may harm competitiveness and slow growth further ahead.
That said, fiscal stimulus in Germany should support growth across the eurozone next year, which will offset much of the slowdown caused by US tariffs and a stronger euro. However, we think there’s a chance that increased defence and infrastructure spending will deliver a smaller boost to growth than we currently expect. In this scenario, further interest rate cuts would be necessary as the ECB turns its focus towards boosting growth.
Ireland’s domestic economy held firm in Q3
For Ireland, we think the domestic economy has remained robust in Q3. Granted, preliminary GDP estimates show a 0.1% contraction, but that looks to have been driven by the multinational sector. Indeed, retail sales grew 0.6% q/q in Q3, which suggests consumers maintained their recent spending patterns and will support domestic demand in Q3.
We think that further interest rate cuts against the backdrop of a tight, albeit moderating, labour market and a resilient domestic economy run the risk of overheating the economy and pushing up inflation. Interest rates remaining on hold is therefore reassuring for the Irish economy’s prospects.
All told, our base case is for the ECB to keep interest rates on hold for the foreseeable. However, if increased defence spending doesn’t boost growth by as much as we expect, then we think the ECB will pursue further rate cuts to support growth.
