Europe: ECB’s next move after pausing interest rate cuts

■ The Eurozone's policy rate is approaching neutral, ahead of other developed countries, and the European Central Bank (ECB) has shifted to a pause in rate cuts.  
■ Considering the medium-term price outlook and risk factors, the next step may be additional rate cuts after 2026. 
 
 
As the Eurozone's policy rate was the first to approach neutral, the European Central Bank (ECB) halted its continuous rate cuts since June of last year in July and held its key policy rate steady for the second consecutive meeting in September. While economic growth was still assessed as "subject to downside risks" in July, uncertainty surrounding trade policy eased with the conclusion of the EU-U.S. trade agreement at the end of July, leading to an increase in the ECB's risk assessment to "more balanced" in September. The ECB maintains its policy of "data-driven policy decisions at every meeting," but President Christine Lagarde has made it clear since July that the monetary policy cycle implemented since 2020 in response to the COVID-19 pandemic and the energy crisis has concluded. With prices already stable around the inflation target, the need for additional rate cuts is considered minimal unless there are significant changes in the price situation or medium-term outlook. 
 
The ECB Council's updated macroeconomic projections in September projected that the Harmonized Index of Consumer Prices (HICP), used as a reference indicator for the inflation target, would rise by 2.1% in 2025, 1.7% in 2026, and 1.9% in 2027. The effects of the current decline in energy prices will almost completely dissipate in the first quarter of 2026, and energy prices may rebound in 2027 with the implementation of the new Emissions Trading Scheme (ETS2). However, inflation is projected to remain below target in 2026 and 2027. 
 
Furthermore, the September projections included sensitivity analyses of energy prices, exchange rates, and US tariff policies, indicating that the ECB considers these to be key risk factors. Regarding exchange rates, the distribution in the euro/dollar options market in mid-August favored an appreciation of the euro. Under the 75th percentile scenario (1.24 in 2026 and 1.28 in 2027), this would reduce real GDP growth by approximately 0.2 percentage points and the HICP by approximately 0.2-0.3 percentage points. Regarding US tariff policy, the impact of diversifying US import sources, declining Chinese export prices, and international supply chain disruptions was analyzed. Excluding supply chain disruptions, which the ECB believes have reduced risk due to the EU-US trade agreement, the impact of declining Chinese export prices is even greater, projecting a reduction of approximately 0.2 percentage points in Eurozone real GDP growth in 2026 and a decrease of approximately 0.1 percentage points in the High Income (HICP) in 2026-2027. 
 
In summary, if exchange rate and Chinese export price trends lead to below-target inflation between 2026 and 2027, the ECB's next move is more likely to be additional interest rate cuts starting in 2026 rather than a shift to rate hikes.