ECB account reveals stable rate outlook amid resilient economy

The European Central Bank's Governing Council account from December 2025 indicates that expectations for further rate cuts have vanished. Instead, markets and survey participants now anticipate policy rates to remain stable for an extended period, with a potential rate hike beyond 2026, driven by a resilient euro area economy and persistent services inflation.

Rate cut expectations vanish

Since the Governing Council's October 2025 meeting, the financial market narrative has consolidated around stable ECB interest rates, with expectations of further rate cuts vanishing.

The overnight index swap (OIS) forward curve shifted significantly upwards, as investors priced out any additional interest rate cut in 2026. Beyond 2026, both market pricing and survey participants suggest the ECB's next policy move would be a rate hike, with interest rate markets seeing the first hike in 2027 and surveys in 2028. This shift is primarily driven by a more resilient outlook for euro area growth, with macroeconomic data mostly surprising on the upside in 2025. Longer-term risk-free rates have increased by 26 basis points, mainly due to higher real rates and expectations of tighter ECB policy.

Equity markets remain near record highs, supported by strong global risk sentiment, including an AI rally in both US and euro area firms.

Sovereign and corporate bond spreads are compressed, and financial conditions have remained broadly stable since the last rate cut in June, indicating smooth policy transmission.

US technology sector debt issuance, projected to grow further, could also have implications for corporate and sovereign bond markets.

Inflation stabilizes, growth resilient

Euro area overall inflation held steady at 2.1 percent in November, remaining stable within a narrow range since spring.

The December 2025 Eurosystem staff macroeconomic projections for the euro area see headline inflation averaging 2.1 percent in 2025, 1.9 percent in 2026, 1.8 percent in 2027, and 2.0 percent in 2028. Core inflation is projected to ease from 2.4 percent in 2025 to 2.2 percent in 2026 and 1.9 percent in 2027, before settling at 2.0 percent in 2028. Underlying inflation indicators remain consistent with the 2 percent target.

Wage growth, though moderating slower than anticipated, is expected to decelerate.

The euro area economy grew by 0.3 percent in the third quarter, driven by consumption and investment, with services leading growth.

The labour market remains resilient, with unemployment at 6.4 percent in October.

No cuts, only patience

This account clearly marks a significant shift in the ECB's outlook, moving from a cautious easing bias to a prolonged period of stable rates.

The persistent stickiness of services inflation, despite overall moderation, remains a critical challenge that underpins this shift.

The Governing Council's focus has decisively moved from managing disinflationary risks to ensuring a firm anchoring of expectations around the 2 percent target.