Market Update: Rates on hold, risks more balanced: ECB signals a steady approach

Highlights: The European Central Bank (ECB) Governing Council (GC) kept its three key interest rates unchanged, with the deposit facility at 2.00 per cent, the main refinancing operations rate at 2.15 per cent, and the marginal lending facility at 2.40 per cent. Inflation is currently broadly in line with the 2 per cent medium-term target, and the GC reiterated its data-dependent, meeting-by-meeting approach while avoiding pre-commitment to a specific rate path.

• The latest ECB staff projections present a broadly unchanged inflation profile, with headline inflation forecasted to average at 2.1 per cent in 2025, 1.7 per cent in 2026, and 1.9 per cent in 2027, while core inflation (excluding energy and food) is expected at 2.4 per cent in 2025, 1.9 per cent in 2026, and 1.8 per cent in 2027. Growth has been revised modestly higher for 2025 to 1.2 per cent, but projections for 2026 were trimmed slightly to 1.0 per cent, with 2027 number unchanged at 1.3 per cent
• The ECB underlined that inflation has reached its target and remains determined to ensure it stabilises sustainably there, supported by effective monetary policy transmission
• It can be inferred that the ECB’s latest decision to hold rates steady underlines a cautious stance, with policymakers balancing between signs of fading resilience and the risk of renewed weakness. While headline inflation is broadly in line with target, forward-looking data suggest that underlying demand pressures are softening. The drag from US tariffs, weaker investments, and slowing external demand are beginning to show more clearly in the Eurozone outlook. However markets are now leaning toward the view that the ECB’s rate-cutting cycle is behind us, especially after President Lagarde signalled that growth risks look more balanced, and the phase of disinflation has largely run its course
• We remain selective in Eurozone assets and favour high-quality IG bonds and defensive sectors while positioning for volatility in cyclical sectors. Overall we remain neutral on Eurozone equities but prefer Spain and Italy, given better cyclical momentum compared with Germany and France. In fixed income, gilts and UK and EUR IG are our picks. Gold and USD diversification also act as effective hedges in this environment. Overall, our stance remains constructive but cautious, i.e. leaning into resilience where it exists, while preparing for a more supportive policy backdrop in the months ahead