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The European Central Bank (ECB) unanimously voted to hold the deposit rate at 2% this month for the fourth consecutive meeting. Without any big surprises, that position looks unlikely to change at the next meeting. Growth will be stronger across the forecast period. However, inflation will undershoot the ECB’s target in the medium-term. The question going forward is whether fiscal stimulus from Germany’s increased defence spending will offset the impact of US tariffs. The ECB’s hawks have been talking up a rate hike, but we think that the extra defence spending may not be as much of a boost to growth as expected. Ultimately, we anticipate that the ECB’s next move, when it eventually comes, will be another rate cut.
Updated ECB forecasts strengthen the case for future rate holds
The ECB voted to keep interest rates at 2% at its meeting on Thursday as the Governing Council continues to balance steady growth with inflation that’s staying close to 2%.
While the ECB’s latest meeting brought little new news, the ECB did update its forecasts, which help to explain the decision to hold. Indeed, the ECB upgraded its growth forecast for this year and next by 0.2ppts each, taking them to 1.4% for 2025 and 1.2% for 2026.
What’s more, the ECB expects inflation to be close to the 2% target across the forecast period, albeit slightly lower than previously expected in 2027 due to the delay to the EU’s carbon-pricing scheme. Inflation sustainably around the 2% target until 2028 and a stronger growth outlook suggest no need for the ECB to move anytime soon.
Ultimately, the ECB will be content to hold rates at 2% for the foreseeable future, barring any unexpected shocks, such as another escalation of US tariffs, which could force the Governing Council to act.
Hawks becoming stronger, but expect the next move to be down
Both market pricing and the ECB’s messaging suggests that rates are on hold for 2026. It’s difficult to argue with that view. However, we think the next move will be downwards, despite hawks’ increasing calls for a rate hike.
This is because much of the impact from US tariffs is still to come, which will drag on growth. While uncertainty around trade policy has come down significantly, we think the impact of US tariffs on growth is still yet to play out fully as supply chains continue to re-adjust.
Inflation is also set to undershoot the 2% target in 2026 and 2027. This raises the likelihood that the ECB pushes ahead with a rate cut to support growth in the meantime. What’s more, if global oil prices continue to head lower, then the ECB may worry about a more material undershoot in inflation.
The hawks’ argument is that the big increase in Germany’s defence and infrastructure spending will offset the weakness caused by US tariffs, which will support inflation. However, we think there’s a chance that Germany’s fiscal splurge delivers less growth than anticipated, which could lower the risks to inflation.
All told, there’s currently little reason for the ECB to shift in either direction anytime soon. Indeed, ECB President Lagarde said “we simply cannot offer forward guidance” and that “all optionalities should remain on the table”. Until there’s clearer evidence on the impact that German defence spending and US tariffs are having on the economy, the ECB rate will be on hold.
Ireland’s domestic economy held firm in Q3
For Ireland, the domestic economy grew strongly in Q3. Inflation has risen to 3.2%, although this is being driven by base effects. Low interest rates will continue to support growth alongside expansionary fiscal policy. However, we think that against the backdrop of Ireland’s tight, albeit moderating, labour market, infrastructure shortages and a resilient domestic economy, the recent rise in inflation could be more persistent than currently expected. That would necessitate spending restraint from the government to help weigh on inflation given the ECB’s focus on Germany and France, where the outlook is weaker.
All told, our base case is for the ECB to keep interest rates on hold throughout 2026. However, if increased defence spending doesn’t boost growth by as much as we expect, then the ECB will probably cut once more to support growth.
