Following its October meeting, the European Central Bank’s (ECB) Governing Council decided to keep its three key interest rates unchanged, as inflation remains close to the 2% target. In a recent Natixis CIB Research webinar, ECB Vice President Luis De Quindos discussed strategies and forecasts for managing inflation with our Head of EMEA Economic Research, Alain Durré.
The Governing Council comes out of its latest meeting with a greater growth optimism on price stability. Trade deals with the US and a ceasefire in the Middle East have balanced risks, but uncertainty remains high. The ECB continues to follow a data-dependent and meeting-by-meeting approach, basing interest rate-setting decisions on the evolution of inflation, projections for future price pressures, and the transmission of monetary policy.
Current projections indicate that inflation is on track to meet the 2% target, following the baseline scenario set out in the Council’s prediction. Services inflation – the largest contributor to EU inflation in 2024 – has slowed to 3% as wage evolution cooled.
Growth and monetary policy measures
Despite global uncertainty, growth in the Euro area remains resilient. Eurostat shows improved growth in the EU for Q3, averaging at 0.3% – up from 0.2% in Q2 – and is predicted to average 1% for the full year. While modest, the growth rate is in line with previous ECB projections.
Along with previous interest cuts, the Council’s ongoing strategy of quantitative tightening is boosting price resilience by reducing liquidity, slashing securities balance sheets by approximately EUR 40bn per month and increasing the cost of borrowing.
Nevertheless, liquidity in the Euro area remains ample, as the quantitative tightening has not impacted repo or cash markets, and government bonds show a reduction in spreads. As such, the Council intends to maintain quantitative tightening alongside interest rate policy as a key tool to manage inflation.
Structural challenges remain
Outside the EU, high levels of uncertainty on global trade policy and cross-border conflict persist. While the EU-US trade deal and ceasefire in the Middle East have mitigated some concerns, the continued war in Ukraine and ongoing trade hostilities between the US and China could negatively affect price stability. Reduced trade flows between major economies may lead to a flood of low-cost imports into the EU, pressuring domestic markets.
The Euro’s appreciation could also impact competitiveness. Even if the ECB does not set exchange rate targets, Vice President De Quindos points out that euro exchange rate is part of the indicators followed by the ECB. Beyond external forces, the Council is focused on internal disparities: approximately 50% of EU member states, including key manufacturing hubs like Italy and Germany, show flat GDP growth. Boosting even growth across the bloc will depend heavily on increasing consumer confidence and spending.
Meanwhile, high savings rates are moderating consumption, despite low unemployment and rising job creation. Fiscal policies, including increased defence spending to improve European autonomy, contribute to this trend. Consumers are effectively saving in anticipation of future taxes – a phenomenon known as the Ricardian equivalence effect. While labour market improvements may gradually increase household incomes and reduce savings rates, consumption recovery is currently slower than expected, highlighting the structural issues beyond monetary policy.
Monetary policy is not almighty
Addressing obstacles to stronger growth recovery will require structural reforms outside monetary policy. Along with high levels of external uncertainty, EU countries are contending with long-standing domestic issues. The housing market is in a contradictory position with real estate going up while construction slows, increasing rents for young workers.
Resolving this depends on balancing rent levels with immigration. As many countries in Europe face an ageing population, immigration becomes an important policy to maintain growth – however, it risks putting greater pressure on an already strained housing market and generating political backlash. These issues are further exacerbated by episodes of political gridlock, with countries like Spain and France failing to pass state budgets, creating uncertianty in the economy and hindering long-term financial planning.
Policymakers are pursuing other EU-wide strategic priorities to boost growth. Completing the single market and integrating goods and services is an essential step to fostering integration and remains an essential step to creating a capital markets and savings and investment union. The ECB cannot act alone here: broad reforms depend on participation by sovereign governments with their own economic policies.
Separately, regulatory reform in the banking sector could unlock additional investment opportunities. While European banks are increasingly liquid and profitable, complex regulations limit their capacity to lend and invest. A working group is currently simplifying reporting and capital requirements, aiming to reduce administrative burdens without compromising financial stability.
What’s next?
The Council is set to next meet in December to reflect on how inflation data matches up to the new upcoming projections. Current indicators largely align with the September projections, providing reassurance that interest rate policy and quantitative tightening are effectively managing inflation. The Council intends to maintain the short-term view amid ongoing uncertianty over trade and conflict, keeping monetary policy facilities open.
However, while monetary policy is performing well in stabilising prices in the short term, the ECB acknowledges that sustained growth levels in the long term will require structural reform beyond monetary policy.
