The ECB is Not Done Yet

The European Central Bank (ECB) raised its deposit facility rate by another 50 basis points (bps) to 2.5% at the February meeting, bringing its policy rate into restrictive territory.

The ECB made clear it continues to expect to raise interest rates significantly, aiming to ensure the timely return of inflation to its medium-term target of 2%. Euro area headline inflation for January is expected to have been about 8.5%, and core inflation to again clock in at 5.2% when final numbers are released later this month (both 8.5% and 5.2% appeared in preliminary estimates). A peak policy rate of around 3.25%-3.5% priced in by the market doesn’t look unreasonable given the still large uncertainty over inflation dynamics.

The ECB reiterated that there is more ground to cover on policy rates. The trend in wage agreements still favors workers. The central bank expects growth in compensation per employee to be running at 3.9% year over year in 2025, well above its long-run average of 2.1%. In addition, fiscal policy is largely seen as not targeted enough, and market-based financial conditions are likely still too loose for the ECB’s goals – the market is pricing rate cuts already in the second half of the year.

For inflation to fully normalize back to the ECB’s 2% target, some cooling in the economy and in the labor market is likely needed. The recent underlying economic resilience of the Euro area is therefore not unconditionally good news for the ECB. We remain cautious on European duration near term.

The terminal rate

ECB President Christine Lagarde emphasized that there is no forward guidance on interest rates, and the ECB remains firmly in meeting-by-meeting mode, with inflation dynamics driving the future policy rate path. However, the ECB also announced its intention to raise interest rates by another 50 basis points at its next monetary policy meeting in March, where it will then evaluate the subsequent policy path in light of new staff macroeconomic projections. But Lagarde did suggest there will likely be more rate hikes beyond the next meeting.