ECB holds rates at 2% as trade talks with Washington drag on

The European Central Bank kept its deposit facility rate at 2% on Thursday, pausing a cycle of seven consecutive reductions that had brought borrowing costs down from 4% a year ago. The decision was universally expected. What matters now is the signal it sends about the months ahead. With the euro climbing to multi-year highs and the EU, US trade talks still unresolved, the Governing Council has effectively told markets that patience is the new posture.

Seven cuts, then a full stop

The deposit rate has fallen 200 basis points since June 2024. Each move was framed as a response to disinflation that proved more persistent than the ECB initially expected. By early summer 2025 the bank judged the stance to be broadly neutral, neither stimulative nor restrictive, and the language in the accompanying statement shifted. The phrase "sufficiently restrictive" disappeared months ago. In its place came an explicit acknowledgement that the policy rate now sits at a level the ECB considers appropriate for an economy growing close to potential.

That assessment rests on a growth picture that has surprised on the upside. The flash composite purchasing managers' index for July, released the same morning as the rate decision, rose to 50.8 from 50.2 in June, its highest reading since April 2023. Hamburg Commercial Bank's Cyrus de la Rubia noted that the manufacturing recession is coming to an end and services growth accelerated slightly. The ECB's own nowcasting models had been pointing to quarterly growth of around 0.3% for the third quarter, a pace that would leave annualised expansion near 1.2%.

Trade uncertainty dominates the outlook

Lagarde used the word "exceptional" to describe the uncertainty stemming from trade disputes. The EU and the United States are negotiating what diplomats describe as a 15% baseline tariff on EU goods entering the US market, with the European side preparing retaliatory measures if Washington pushes for more. The talks have dragged on for weeks, and the ECB has made clear it will not commit to a further easing step until the terms are known. A senior official briefed reporters last week that the Governing Council wants to see the "final text" before recalibrating.

The stakes are material. The United States accounts for roughly 18% of eurozone goods exports. A 15% tariff, if applied broadly, would shave an estimated 0.2 to 0.3 percentage points from eurozone GDP over a twelve-month horizon, according to internal Commission modelling seen by this publication. The ECB's June staff projections assumed a modest drag from existing tariffs but not a significant escalation. If the negotiations collapse, the growth forecast would need revision.

Euro strength adds a second headwind

While policymakers wait on trade, the currency has moved on its own. The euro has appreciated nearly 6% against the dollar since April, touching $1.14 in early July, its strongest level since early 2022. The move reflects a broader reallocation: global reserve managers and sovereign wealth funds have been reducing dollar exposure, citing the erratic policymaking style of the US administration. A stronger euro lowers import prices, which feeds directly into the inflation outlook. The ECB's June projections already saw headline inflation dipping to 1.6% in 2026, below the 2% target. A sustained appreciation of 5% in trade-weighted terms would subtract a further 0.1 to 0.15 percentage points from inflation over the projection horizon, according to the bank's standard exchange-rate pass-through estimates.

Lagarde acknowledged the dynamic but downplayed the 2026 undershoot. "Inflation will return to target in the medium term," she said, using the ECB's standard definition of medium term as roughly two years ahead. That formulation allows the bank to look through a temporary dip without committing to immediate action. It also buys time to assess whether the euro's rise persists once the trade picture clears.

Divergence on the Governing Council

Not every policymaker shares the president's patience. Isabel Schnabel, often described as the board's most hawkish voice, told a conference in Berlin last week that the bar for another cut is "high". Her argument rests on two pillars: first, that underlying inflation, services inflation in particular, remains sticky at around 3.5% year on year; second, that the neutral rate may be higher than the models assume, meaning 2% could still be mildly restrictive. Schnabel's intervention was widely read as a signal that the December meeting, the last of the year, could easily produce a hold rather than a cut.

Financial markets, however, are not convinced. Overnight index swaps still price roughly a 60% probability of a 25 basis point move by December, down from 80% a month ago. ING's Carsten Brzeski captured the consensus view: "Taking today's meeting at face value, the bar for yet another rate cut this year has clearly been raised. Still, we should not rule out a further cut as inflation and other economic data could rather disappoint over the summer." The summer months will bring a flood of data, national accounts for the second quarter, August PMI, the September inflation flash estimate, each capable of shifting the balance.

What the data must show

For a cut to return to the table, three conditions likely need to be met. The trade agreement must be finalised without a damaging escalation. The euro must stabilise or retreat from its current highs. And core inflation must demonstrate a convincing downward trend, not merely a one-month dip. The ECB's own forecasting exercise in September will be the first comprehensive update since June. That projection round will incorporate the trade deal terms, the latest exchange-rate path, and the second-quarter national accounts. If it shows inflation returning to 2% sustainably in 2027, the case for a December cut strengthens. If it shows a prolonged undershoot, the debate shifts to whether the neutral rate estimate needs revision.