ECB keeps rates unchanged, plays down impact of dollar weakness on policy

The European Central Bank left interest rates on hold as expected on Thursday and played down the impact of dollar moves on its future choices, with a largely unchanged inflation outlook also suggesting steady policy for months to come.

 

The euro zone's central bank has been on hold since ending a year-long run of rate cuts in June, and surprisingly resilient growth has taken nearly all pressure off policymakers to provide any further support.

 

The ECB acknowledged continued uncertainties around global trade policy and geopolitical tensions but said it still saw inflation stabilising at its 2 per cent target over the medium term, and that the euro zone economy was travelling on the path outlined in its December projections.

ECB REMAINS IN GOOD PLACE

"We are in a broadly balanced situation at the moment," ECB President Christine Lagarde told a press conference of upside and downside risks to that outlook, reaffirming that monetary policy remained in a "good place".

 

The Governing Council did, however, spend time discussing exchange rate moves after the dollar tumbled last week.

 

Asked about the currency, Lagarde said the ECB was keeping a close eye on markets but ultimately concluded that no big change has taken place in recent months.

 

"In the last few weeks, in fact since the summer, it has fluctuated in a range," she said, adding policymakers had therefore concluded that foreign exchange rate moves since last year were "incorporated in our baseline".

 

The dollar fell sharply early last year around the announcement of tariffs, and that move is still working its way through the economy.

Hoping to capitalise on this shift away from the US currency, governors discussed opening the ECB's liquidity facility more widely, giving central banks outside the euro zone greater access to euros in times of crisis.

MARKETS SEE NO RATE MOVE IN 2026

A strong euro relative to the dollar lowers import costs, especially for energy, curbing inflation at a time when it is already below target, if only temporarily.

 

With the dollar dip unwinding in recent days, the euro is actually weaker on a trade-weighted basis than at the ECB's December meeting, reinforcing market and economist expectations for no interest rate changes in 2026, followed by some policy tightening later in 2027.

 

"Our base case remains that the ECB will stay on hold for the rest of the year," Modupe Adegbembo at Jefferies said, adding that risks are skewed toward the next move being a cut, rather than a hike.

 

"We see little evidence of emerging inflationary pressures: currency appreciation, the potential deflationary impulse from technological innovation, and China's push to diversify its trading partnerships all point toward a softer price environment," Adegbembo said.

 

Lagarde repeated the bank's official line that policy would be data-dependent and that it had no pre-determined rate path.

Inflation, the ECB's primary focus, slipped to 1.7 per cent 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 if anything, longer-term inflation expectations have been inching up, not down, on solid activity data ​and energy price rises.

"The bar remains high for future action," Lorenzo Codogno at LC Macro Advisors said. "Even from a risk-management perspective, the threshold for action remains high." 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.