A Glance at the European Central Bank’s Monetary Policy Outlook – Cutting Cycle Possibly at an End

As the European Central Bank (ECB) approaches the final stages of its monetary easing cycle, businesses and investors across the Eurozone are watching closely. With inflation cooling and external risks mounting, the ECB faces a delicate balancing act. This month’s newsletter explores the latest developments in ECB policy and what they mean for the broader economic landscape.

ECB Holds Steady – But for How Long?

At its July meeting, the ECB kept the deposit rate unchanged at 2%. President Christine Lagarde emphasized the Eurozone’s resilience, noting that inflation expectations remain anchored around the 2% target. However, she also acknowledged significant uncertainty, particularly around trade tensions with the United States and the potential for new tariffs. While markets interpreted Lagarde’s tone as slightly hawkish, analysts at BCA Research believe the ECB will need to cut rates twice more before the end of 2025 to prevent inflation from undershooting its target.

Disinflation Gains Momentum

The Eurozone is experiencing a broad and sustained disinflationary trend. Core inflation is steadily approaching the ECB’s target and services inflation has slowed to 3.4%. Wage growth is also cooling, with the ECB’s wage tracker falling from 5.3% to 1.6%.

Labour market indicators suggest further weakness ahead. Unemployment is rising modestly and hiring intentions are softening. Meanwhile, the euro’s strength – up over 15% against the US dollar since January -is making imports cheaper and contributing to falling consumer prices.

Energy prices have also declined, with Brent crude trading below $70 per barrel and European gas prices remaining subdued. These factors are driving a contraction in import prices and narrowing the breadth of inflation across the region.

Deflation Risks Loom

While disinflation is entrenched, the risk of outright deflation is increasing. China’s GDP deflator is shrinking and the euro’s strength against the yuan is giving Chinese exporters a competitive edge. This threatens European profit margins and pricing power.

Trade tensions with the US could exacerbate the situation. If Brussels accepts a Japan-style trade deal, European goods may face a 15% tariff when entering the US market. Combined with a strong euro, this would further erode margins and amplify deflationary pressures.

Fiscal policy offers limited short-term relief. Although Germany has announced easing measures, significant spending won’t materialize until 2026. In the meantime, financial conditions have tightened, creating a restrictive environment that could stifle growth.

Room to Ease Without Risking Bubbles

Encouragingly, the ECB has room to ease further without triggering financial instability. Banks are maintaining tight lending standards and there is no evidence of excessive risk-taking in corporate lending, housing, or consumer credit. This gives the ECB confidence that additional rate cuts may not fuel asset bubbles.

Investment Implications

BCA Research recommends positioning for deeper ECB easing than markets currently expect. Two more rate cuts would lower the deposit rate to 1.5% by year-end, supporting lower bond yields and tighter spreads across the Eurozone. Investor sentiment is improving, with forward-looking indicators such as the ZEW growth expectations and the German Ifo index turning positive. Households are also in a strong financial position, with high asset-to-debt ratios and rising confidence. Fiscal support legislated earlier this year will begin to reach the real economy in 2026, reinforcing private-sector resilience just as monetary policy becomes more accommodative.

As the ECB nears the end of its easing cycle, the risks of deflation and external shocks mean that further action is likely. Businesses and investors should prepare for a more accommodative stance in the months ahead, while remaining vigilant to the evolving macroeconomic landscape.

If your business is exposed to currency fluctuations, it is essential to have a robust currency risk management policy in place. For insights into current market conditions and strategies to navigate them effectively, feel free to get in contact with us – phone 021 819 7804 or email Evan May at emay@wauko.com or David du Plessis at dduplessis@wauko.com.