The ECB may be standing still, but the ground beneath is shifting. With eight rate cuts behind it since September 2023 and another still on the table, the second half of the year could bring more drama than the quiet summer suggests. The path forward is shaped by geopolitical risk, market tension and a euro that is proving uncomfortably strong.
Recent commentaries and research from Pimco, Crédit Mutuel, Berenberg and others suggests that while the ECB is likely to pause in July, its policy path beyond the summer remains wide open.
Cautious pivot
The ECB’s June rate cut marked a careful shift.
“With inflation broadly at target, we think the cutting cycle is nearing its end,” said Konstantin Veit, portfolio manager at Pimco. Many on the Governing Council now see the two percent deposit rate as a neutral midpoint, offering flexibility in either direction.
François Rimeu, strategist at Crédit Mutuel Asset Management, echoed this view in a recent note. He expects a pause in July, calling the two percent level broadly appropriate for the current macroeconomic environment, especially as inflation gradually approaches the ECB’s target.
Still, that flexibility may be tested.
“The ECB will want to preserve conventional policy space and will aim to minimize the risk of reversing course shortly after reaching the terminal rate,” Veit wrote.
September outlook
The summer lull will not last. The 11 September meeting, which includes new ECB projections, is shaping up to be the key turning point. Until then, the central bank must assess incoming inflation data, contend with a strengthening euro and monitor the fallout from trade tensions with Washington.
“Trump is currently threatening the EU with a baseline tariff rate of 30 percent,” Berenberg noted in a research update. “While the outcome is hard to predict, the ECB will likely have a much clearer view by its next meeting.”
AXA also flagged a potential shift. Dovish overtones in Christine Lagarde’s recent press conference suggest that downside risks to the euro area outlook have increased.
Rimeu suggested that the ECB’s communication strategy could shift from a strictly data-dependent stance to a more forward-looking, risk-based approach, particularly now that the two percent inflation target has effectively been met.
“Decisions would still be taken meeting by meeting, without pre-committing to any path,” he wrote.
Strong euro complicates picture
Since May, the euro has appreciated by more than 3 percent against the dollar, a move that may please officials in Berlin or Paris but poses challenges for the ECB.
“A stronger euro makes imports cheaper and carries disinflationary risks,” Berenberg warned. “A rise beyond 1.125 euros to the dollar could prove tricky for policymakers.”
On Tuesday, the euro traded at 1.17, up from near-parity at the start of the year.
Credit Mutuel noted that while Lagarde may downplay the currency’s influence, the exchange rate adds complexity to the ECB’s inflation assessment. The central bank does not target exchange rates, but their effects on consumer prices are material and may undermine progress toward a lasting price rebound.
In a worst-case scenario, the ECB could be pushed into another rate cut not because the economy is weakening, but to preserve its inflation mandate.
“Unless trade tensions or a stronger euro increase disinflationary pressure, we do not expect the ECB to lower the deposit rate below two percent,” said Felix Schmidt, senior economist at Berenberg.
Rate outlook ahead
The key question is not what happens this week, but how the ECB steers policy through year-end. UniCredit expects a pause, while ING’s Carsten Brzeski anticipates further easing.
“The question is not if, but when and by how much,” Brzeski wrote.
Bank of America is more bearish. It forecasts a terminal deposit rate of 1.5 percent by year-end and recommends investors “receive October ECB €STR,” a futures trade that profits if short-term euro rates fall faster than currently priced. The bank expects two further cuts in September and December, versus just 15 basis points currently priced in by markets.
Rimeu expects no major surprises from the July meeting and sees market impact as limited. He anticipates a continued wait-and-see stance, with the ECB emphasizing caution and flexibility ahead of September’s updated projections.
A delicate descent
With inflation near target but several headwinds on the horizon, Lagarde’s challenge is to engineer a soft landing without oversteering. The ECB is attempting to navigate economic turbulence without committing too early to a final landing.
“This is another reason for the ECB not to lower the deposit rate further at the upcoming meeting, but to keep some policy space in reserve just in case,” Berenberg wrote.