The ECB hasn’t cut interest rates since June. — Reuters
FRANKFURT: The European Central Bank is all but certain to keep interest rates unchanged on Thursday and signal that no policy move is imminent, even if the euro's recent surge against the dollar fuels concerns that inflation might undershoot its target.
The euro zone's central bank has been on hold since ending a year-long run of rate cuts in June, and a benign outlook for both growth and prices has taken nearly all pressure off policymakers to provide any further support.
With inflation near the 2% target, growth steady at the currency bloc's potential and interest rates in a neutral setting, some have called the current period a central banker's nirvana or the ECB's "Goldilocks" moment.
MESSY ENVIRONMENT THREATENS 'GOOD PLACE'
That is why ECB President Christine Lagarde is likely to repeat her mantra that policy is in a "good place", with no debate over changing borrowing costs likely in the near term.
But last week's tumble in the U.S. dollar, volatility in commodity markets, the Trump administration's war of words over Greenland and its pressure on the Federal Reserve to cut rates, are all reminders that the situation could quickly change.
"From the ECB policy standpoint there are good reasons to avoid reading too much into this whole story," TS Lombard's Davide Oneglia said.
"Solid activity, wage, and bank lending data take priority, with recent releases supporting an increasingly sanguine view of euro area recovery and medium-term core inflation," he argued.
Thursday's meeting is the first since Bulgaria joined the bloc on January 1, taking the number of countries that share the euro currency to 21.
DOLLAR'S FALL NOT A PROBLEM YET
A strong euro relative to the dollar lowers import costs, especially for energy, and curbs inflation at a time when it is already undershooting the ECB's target.
Inflation, the ECB's primary focus, slipped to 1.7% across the euro zone last month on lower energy costs, and could dip further before a forecast rebound next year, stirring memories of the ECB's struggle to rekindle price growth for the decade before the COVID pandemic.
But the dollar's move is not a deal-breaker for now.
"A rally in the dollar following the nomination of Kevin Warsh to the U.S. Federal Reserve should alleviate concerns around euro strength and a more persistent inflation target undershoot," HSBC's Anja Sabine Heimann said.
On a trade-weighted basis, the euro has actually weakened a touch, reinforcing market and economist expectations for no interest rate changes in 2026, followed by some policy tightening later in 2027.
If anything, longer-term inflation expectations have been inching up, not down, on solid activity data and energy price rises.
EUROPE HAS A COMPETITIVENESS PROBLEM
For now, Lagarde is likely to repeat that the ECB has no exchange rate target and that the euro's strength is merely one factor that impacts inflation.
She is also likely to point to healthy economic growth figures, historically low unemployment, and solid wage growth data to support a sanguine tone.
The euro zone has proven surprisingly resilient to trade strife as domestic consumption seems to be taking up the slack created by weak exports and poor industrial production.
Given exceptionally high domestic savings and a strong labour market, economists expect consumption to keep the bloc growing, with the German government's planned fiscal splurge on defence and infrastructure a further push to expansion.
"The path of monetary policy in 2026 will depend on who wins the contest between external conditions and internal conditions," Deutsche Bank said in an analysis. "Our baseline assumes that domestic resilience will dominate and that leads to (interest rate) hikes in 2027."
Risks could still go the other way, however, and if inflation is below target long enough to drag expectations below 2%, policymakers may have no choice but to provide more support. - Reuters
