ECB holds rates at 2% and upgrades growth forecasts as trade fears fade

The European Central Bank kept its deposit facility rate at 2% on Thursday, the fourth meeting in a row without a change, and published staff projections that paint a noticeably brighter picture for the euro-area economy than the ones issued in September.

The headline revision is to growth. The ECB now expects the euro area to expand by 1.4% this year, up from the 1.2% forecast three months ago. For 2026 the projection rises to 1.2% from 1.0%, and for 2027 to 1.4% from 1.3%. The bank also published its first ever forecast for 2028, pencilling in 1.4% growth. The upgrades reflect a year in which the destructive trade war with the United States that many feared six months ago failed to materialise, and the risk of a wider Middle East conflict receded.

Why the forecasts have improved

The brighter outlook rests on two geopolitical developments. First, the European Union and the United States avoided an escalation of tariff threats that had dominated the first half of 2025. The European Commission and the Biden administration, and later the incoming Trump team, settled on a managed framework for steel, aluminium and automotive trade that removed the most damaging uncertainty for exporters. Second, the containment of the Gaza conflict prevented a sustained energy-price spike that would have hit household purchasing power and industrial competitiveness simultaneously.

Those external tailwinds coincided with a stronger-than-expected third quarter, in which euro-area GDP grew 0.3% on the quarter. Business surveys, the composite PMI and the European Commission's own economic sentiment indicator, have signalled continued expansion through the year-end, suggesting the momentum carried into the fourth quarter. Domestic demand, particularly services consumption and residential investment, has proven more resilient than the ECB's models anticipated in September.

Inflation path barely changed

While growth forecasts moved meaningfully, the inflation trajectory is almost unchanged. The ECB sees headline inflation at 1.9% in 2026 and 1.8% in 2027, compared with 1.7% and 1.9% in September. The first projection for 2028 puts inflation at exactly 2%, the level the Governing Council defines as price stability over the medium term. Core inflation, which strips out energy and food, is expected to follow a similar glide path, easing gradually as wage growth moderates and profit margins normalise.

The near-term inflation dynamics remain messy. Energy base effects will push headline rates around in the first half of 2026, while services inflation, the stickiest component, is only slowly returning to levels consistent with the 2% target. The ECB's statement repeated its standard formulation that it will respond to any material changes if incoming data demand it, a phrase that has become a holding pattern for a council that no longer sees a clear directional bias.

A long pause priced in

Financial markets and the overwhelming majority of economists now expect the deposit rate to remain at 2% throughout 2026. Money-market curves imply roughly a 20% chance of a 25-basis-point cut by June and a similar probability of a hike by December, effectively pricing a symmetric distribution around the current level. That is a striking shift from a year ago, when the debate was about how quickly the ECB could cut from the 4% peak reached in September 2023.

The pause reflects a genuine dilemma. Growth is no longer weak enough to justify further easing, but inflation is not yet durably at target in a way that would warrant tightening. The ECB's own language, "restrictive" policy stance, has quietly disappeared from statements, replaced by data-dependence rhetoric that leaves maximum optionality. For businesses and households, the message is that borrowing costs are likely to stay where they are for the foreseeable future.

Open divisions on the Governing Council

Beneath the consensus on today's decision, the council is visibly split on what comes next. Isabel Schnabel, the executive board member responsible for market operations, said last week in a speech in Frankfurt that she believes the next move is likely to be up. Her argument rests on the risk that the labour market remains tighter than models assume, keeping wage growth above the 3% level consistent with 2% inflation over the medium term.

At the other end, Olli Rehn, governor of the Bank of Finland, kept the door to further easing ajar in an interview with the Financial Times published on Monday. He warned that downside risks to the inflation outlook still dominate, citing the possibility of a sharper-than-expected slowdown in China and the lagged impact of past rate hikes on credit-constrained firms. Rehn's view carries weight because Finland's economy, heavily exposed to trade with Russia before 2022 and to the technology cycle, has been a leading indicator for euro-area turning points.

Other governors have positioned themselves between those poles. Joachim Nagel of the Bundesbank has stressed that the ECB should not declare victory on inflation too early, while François Villeroy de Galhau of the Banque de France has argued that the restrictive stance has done its job and that the council should be ready to cut if growth disappoints. The diversity of national economic cycles, Germany flirting with stagnation, Spain growing above 2%, France somewhere in between, makes a unified view genuinely difficult.

What Lagarde will face at the press conference

Christine Lagarde's 14:45 CET press conference will be the first real test of whether she can articulate a coherent framework for this new phase. In previous cycles, she has used the language of "journey" and "landing" to guide markets. Now the metaphor is less clear. The ECB is neither hiking nor cutting, and the forecast horizon extends to 2028 with inflation exactly at target, a Goldilocks outcome that few forecasters assign high probability to.

Journalists will press her on the Schnabel-Rehn divergence, on whether the council has discussed the neutral rate, the level that neither stimulates nor restricts, and on how the ECB interprets the recent rise in long-term bond yields across the euro area. The 10-year Bund yield has climbed from 2.1% in September to 2.6% this week, tightening financial conditions independently of the ECB's policy rate. If Lagarde acknowledges that market tightening is doing some of the council's work, it could signal comfort with the current pause.

The fiscal backdrop matters more than usual

Monetary policy is not operating in a vacuum. The euro area's fiscal stance is shifting from supportive to neutral or slightly restrictive as pandemic-era support measures expire and the Stability and Growth Pact rules are reapplied in 2026. Germany's debt brake, France's deficit-reduction plan, and Italy's negotiation with the Commission over its structural budget plan will all withdraw demand at the margin. The ECB's upgraded growth forecasts assume a fiscal drag of roughly 0.3 percentage points in 2026 and 0.2 in 2027, but the final numbers depend on political negotiations that are far from settled.

At the same time, the Recovery and Resilience Facility continues to disburse funds, particularly to Spain, Italy and Poland, providing an offsetting impulse. The net fiscal effect is uncertain enough that the ECB's staff explicitly flag it as a key risk to the projection. Lagarde will almost certainly be asked whether the council has a view on the appropriate fiscal-monetary mix, a question she typically deflects to national capitals and the Commission.

What happens next