ECB keeps policy rates unchanged and expects higher growth and an inflation rate in line with its policy target
No surprises in policy decision
As expected, the ECB kept its policy rate, the deposit rate, unchanged at 2% at its policy meeting on 18 December. That means the refinancing rate and the marginal lending rate also remained unchanged at 2.15% and 2.40% respectively. This decision is in line with our scenario that this level is the bottom of the current interest rate cycle.
As usual, the ECB declined to provide "forward guidance" for its future interest rate decisions. It reiterated that those decisions will be data-dependent, meeting-by-meeting and that it does not pre-commit to a specific future interest rate path.
ECB president Lagarde reiterated that the ECB sees itself in a ‘good place’ with the current interest rate level, which, however, is not static but completely data-dependent. That communication meant the ECB did not want to confirm the recent communication from some ECB policy makers, including Isabel Schnabel, that the next interest rate change would be upward. As the current interest rate decision was already almost fully priced into the market, its communication had little impact on the German 10-year bond yield.
In addition, Lagarde once again called on European leaders to make progress on the functioning of the European single market, the creation of the capital market union and the further preparation of the digital euro.
New macroeconomic projections
New projections from ECB economists were available at the December policy meeting. Regarding inflation, the forecast for 2026 was revised upwards by 0.2 percentage points to 1.9%, mainly due to a slower-than-expected decline in services inflation. This in turn is linked to the slightly upward surprise of recent wage growth in the euro area. The postponement of ETS2 from 2027 to 2028 is reflected in the projections by an increase in expected inflation from 1.8% in 2027 to 2.0% in 2028. The main conclusion for the ECB from this is that it expects inflation to stabilise around its 2% target over the medium term.
Specifically, according to ECB economists, expected inflation is 2.1% in 2025 (unchanged from the September projections), 1.9% in 2026 (up from 1.7%), 1.8% in 2027 (down from 1.9%) and 2.0% in 2028 (no basis for comparison). Over the projection horizon, underlying core inflation (excluding energy and food) also remains very close to the ECB's 2% target at 2.4%, 2.2%, 1.9% and 2.0% in the years 2025 to 2028, respectively.
On the growth outlook, ECB economists became more optimistic in December compared to September. This is mainly based on expectations for domestic demand growth, especially consumption and investment (both public and private). Recent growth contributions from net exports were also a positive surprise for the ECB, despite the challenging environment for international trade. Specifically, ECB economists expect annual average growth of 1.4% in 2025 (up from 1.2% in the September outlook), 1.2% in 2026 (up from 1.0%) and 1.4% in 2027 (up from 1.3%). For 2028, the forecast remains stable at 1.4%.
Upward growth expectations possibly more than just a once-off phenomenon
ECB president Lagarde underlined that the upward revision of the growth outlook for 2026 was based, among other things, on private investment, in addition to an expected stronger growth in consumption and public investment. That private investment, she said, is largely related to a focus on artificial intelligence (AI). Lagarde announced that the ECB is looking deeper into this topic to see if this is more than a temporary phenomenon. She suggested between the lines that AI could well raise the eurozone's trend growth rate, though without expressing it in those terms. On a possible impact of this on the neutral interest rate, the so-called r*, she was even less willing to comment. She rightly stressed that this is, after all, an unobservable concept, which, moreover, is not static in a macro-financial environment still characterised by high uncertainty.