ECB to hold rates steady as euro zone economy shows resilience

Recent growth figures for the 20-country currency bloc have beaten ECB expectations, buoyed by exporters navigating U.S. tariffs more effectively than anticipated and by domestic spending that has counterbalanced a malaise in manufacturing.

Inflation, meanwhile, has been hovering around the ECB's 2% target, boosted by price hikes in the services sector, and is expected to stay there for the foreseeable future.

That is likely to mean the ECB raises some of its growth and inflation forecasts on Thursday - effectively, though not explicitly, drawing a line under an easing cycle that saw it halve its policy rate from 4% to 2% in the year to last June.

Some members of the ECB's Governing Council had wanted to do so at their last meeting in October.

"The haze of economic uncertainty has somewhat lifted, especially regarding trade," Lorenzo Codogno, founder of LC Macro Advisors, said. "This will give the Governing Council greater confidence that it is in a good spot, likely eliminating any remaining easing bias."

Rate Hike Next? 

ECB President Christine Lagarde may even be asked if rates are next set to go up, as some traders have started betting. But this debate is seen by many as premature given ample idle capacity in the manufacturing sector.

"I would expect Christine Lagarde to steer clear of rate hike conversations," Spyros Andreopoulos, founder of the Thin Ice Macroeconomics consultancy, said.

Some comments from ECB board member Isabel Schnabel, chief economist Philip Lane and Lagarde herself have helped fuel some speculation about a rate hike late next year.

Financial markets have begun pricing modest chances of a rate hike late next year or early in 2027 .

But most economists polled by Reuters expect the ECB to leave rates where they are through 2026 and 2027, although the forecast range for the latter year was wide at 1.5%-2.5%.

"The reality is, the bar is probably quite high for a move in either direction in the next few meetings," BNP Paribas chief economist Isabelle Mateos y Lago said.

Higher Projections For Growth And Inflation 

The ECB can otherwise do little but acknowledge the euro zone economy is now growing close to its potential at roughly 1.4% per year, that sentiment is recovering and that industrial output is showing signs of bottoming out.

Economists expect growth to carry forward into next year, supported by the German government's planned investments in defence and infrastructure and a relatively tight labour market, where workers have finally seen their wages catch up with the post-pandemic surge in prices.

"A stable labour market, a growing service sector, and the German fiscal stimulus will provide a tailwind to the euro zone economy in the coming months," Felix Schmidt, a senior economist at Berenberg, said.

Lagarde herself has said the ECB will increase its economic growth projections - which currently see GDP expanding 1.2% this year, 1.0% in 2026 and 1.3% in 2027 - and economists expect it to nudge up its core inflation forecasts for 2026-27 too.

These will be crucial to watch as they factor out the effect of a delay to the European Union's carbon trading scheme, which will mechanistically bring down headline inflation in 2026-27 and push it up in 2028.

Among factors likely to weigh on inflation is the euro's strength against the Chinese yuan or renminbi, which is making it even harder for the euro zone to compete with China, and against the U.S. dollar, which may fall further if the Federal Reserve cuts rates more rapidly under a new chair.

"When you look at the trade balance of Europe, it appears that the competitiveness problem is much more pronounced against China than against the U.S. For me, the exchange rate to look at is not the dollar-euro, it's the euro-renminbi," BNP's Mateos y Lago said.