No 'risk management' cut in ECB policy rate

ECB president Lagarde reiterated that the ECB is in a good position. Indeed, overall inflation in the eurozone (2.2% in September) is close to the 2% medium-term target. Moreover, ECB policymakers said the inflation outlook was little changed from September. In September, ECB president Lagarde indicated that the disinflation process was complete, with a chance of temporary and limited undershooting in 2026 and 2027. As a reminder, ECB economists in their September projections expected headline inflation to average 2.1% in 2025, 1.7% in 2026 and 1.9% in 2027.

Lagarde also noted that, against the backdrop of a difficult international geopolitical environment, economic growth in the eurozone remained positive (+0.2% quarterly growth in the third quarter). The ECB also referred to the robust labour market, the sound financial situation of the private sector and the pass-through effect of past interest rate cuts by the ECB. Moreover, according to the ECB, a number of downside growth risks have abated, thanks to the US-EU trade agreement during the summer, the ceasefire in the Middle East and the prospects of an (at least temporary) de-escalation of the latest trade tensions between the US and China. Consequently, the ECB considered an additional interest rate cut as a "precautionary measure" at this policy meeting no longer necessary. As the interest rate decision was fully in line with market expectations, the market reaction was limited in terms of German bond yields and the euro-dollar exchange rate.

Divergence of interest rate policy and QT

The bottom of the ECB interest rate cycle contrasts with the latest rate cut by the Fed one day earlier. We assume that the Fed will also cut its policy rate by 25 basis points each time in the coming policy meetings to arrive at its neutral rate, which it itself estimates at around 3%, in the first quarter of 2026. This policy divergence between the Fed and the ECB is also expected to affect the euro exchange rate, which we see continuing to appreciate against the dollar, albeit with very uncertain timing.  

The divergence between the ECB and the Fed is also reflected in their respective balance sheet normalisation policies. While the Fed announced that its quantitative tightening (QT) will end from December because it believes liquidity has been sufficiently reduced, the ECB's balance sheet deleveraging continues to run on autopilot. The ECB's maturing assets in its APP and PEPP portfolios are not reinvested. The ultimate aim is to fully wind down both policy portfolios.

New phase for the digital euro

The main miscellaneous item on the agenda of this press conference was the ECB Governing Council's decision to launch a new phase for the digital euro, now that the preparation phase that had started in November 2023 has been completed. If the legislative framework is created in 2026, a pilot project could be launched in 2027 leading to a potential introduction of the digital euro in 2029. Lagarde stressed that the ECB will only make the final decision on the introduction and concrete timing after the necessary European legislation is in place. Lagarde also stressed that the money issued by a central bank is a ‘public good’, and that, according to the ECB, a digital variant of cash should exist in an environment where physical cash is becoming less and less used. For the ECB, money issued directly by the central bank is the core on which the monetary system rests. A digital euro in digital times is therefore part of European sovereignty, according to Lagarde. According to Fabio Panetta, the president of the Italian central bank and architect of the digital euro who was also present at the press conference, it is even a prerequisite for financial stability in the eurozone.