ECB Holds Fire but Signals 2026 Cuts as Euro Surge Tests Fed Divergence

The European Central Bank (ECB) left interest rates unchanged at its September meeting, a widely anticipated decision that reflects a cautious stance as inflation has drifted back to target but underlying risks remain. Policymakers also released updated quarterly staff projections, offering investors a fresh view on the eurozone’s growth and inflation trajectory. With markets already looking toward the first quarter of 2026 as the next likely window for a rate cut, the September decision was less about action and more about signaling—both through the updated forecasts and President Christine Lagarde’s press conference.

One key point of comparison between the September and July statements lies in the framing of the inflation outlook. In July, the Governing Council emphasized that inflation was at the 2% medium-term target, noting that domestic price pressures had eased and that wage growth was slowing. This language signaled satisfaction with the disinflation trend, while acknowledging that global uncertainty—especially trade disputes—remained a headwind. In contrast, September’s statement highlighted that inflation is “around the 2% medium-term target” and that the assessment of the outlook is “broadly unchanged.” The difference may appear subtle, but it reflects a recognition that inflation progress has plateaued rather than continued to accelerate downward. Policymakers are thus more cautious about declaring victory, even as they acknowledge stability at the target.

The inflation and growth projections released in September sharpened this message. Headline inflation is now expected to average 2.1% in 2025, 1.7% in 2026, and 1.9% in 2027, essentially unchanged from the June projections. Core inflation excluding energy and food is forecast to average 2.4% in 2025 before easing to 1.9% in 2026 and 1.8% in 2027. These projections underscore that underlying pressures are expected to remain somewhat sticky in the near term before settling back comfortably below the 2% target. For growth, the ECB revised its 2025 forecast upward to 1.2% from the prior 0.9%, reflecting a more resilient outlook for the region. However, the 2026 forecast was nudged lower to 1.0%, and 2027 remains at 1.3%, suggesting a modest but steady expansion rather than a strong cyclical rebound.

The broader guidance language between July and September remained largely the same. Both statements reaffirm the Governing Council’s commitment to a data-dependent, meeting-by-meeting approach and explicitly avoided pre-committing to a rate path. Both also emphasized that decisions will be grounded in the inflation outlook, underlying inflation dynamics, and the strength of policy transmission. The constancy in this framework signals that the ECB sees no need to change its communication strategy at this stage. However, the absence of July’s mention of easing domestic price pressures and wage moderation is notable—perhaps reflecting concern that these drivers may not continue to cool as quickly as earlier hoped.

Lagarde’s press conference is expected to reinforce this cautious tone. While she is unlikely to signal imminent easing, she will almost certainly keep the door open to cuts in 2026, stressing that the Governing Council retains flexibility should the inflation and growth trajectory deviate from projections. Markets are already leaning toward a “short cycle” of ECB cuts beginning early in 2026, mirroring expectations for the U.S. Federal Reserve, which investors anticipate will deliver three cuts before year-end 2025. By leaving its forward guidance unchanged and pointing to balanced risks, the ECB is essentially validating those market expectations without actively endorsing them.

For markets, the exchange rate context remains critical. The euro has strengthened roughly 10% against the dollar this year, trading in a range between 1.15 and 1.18. This level has become a focal point for traders, especially as relative policy trajectories between the Fed and the ECB evolve. If the Fed proceeds with its expected short cycle of three cuts, the dollar could lose some of its support, leaving the euro better bid. However, if the ECB is slower to act or signals less willingness to cut, the single currency could face renewed headwinds. The interaction between the two central banks’ policies is thus poised to be a key driver of the EUR/USD path heading into 2026.

Another continuity between July and September is the ECB’s steady hand on its balance sheet policy. Both meetings reiterated that the Asset Purchase Programme (APP) and the Pandemic Emergency Purchase Programme (PEPP) are declining at a predictable pace, with no reinvestments of maturing securities. This backdrop indicates that balance sheet normalization is firmly on autopilot and is unlikely to be revisited absent a significant shock.

The macroeconomic backdrop complicates the ECB’s posture. On one hand, inflation has returned to target, growth has proven more resilient than expected, and financial conditions remain manageable. On the other hand, geopolitical risks, global trade tensions, and the uncertain path of wage dynamics all caution against premature easing. By keeping policy steady and sticking closely to its established script, the Governing Council is buying time to assess whether the disinflation trend can be sustained without further tightening—or if inflation surprises may reemerge.

In conclusion, the September ECB decision delivered continuity rather than surprise. Rates remain on hold, forecasts show only modest changes, and guidance language was nearly identical to July’s. The key changes were an upward revision to 2025 growth and subtle recalibration of the inflation commentary, both underscoring resilience but also caution. With the euro trading strongly and markets already penciling in a 2026 easing cycle, Lagarde’s task was to balance patience with optionality. She appears to have done just that, leaving the ECB’s posture firmly in wait-and-see territory as the next phase of monetary policy draws closer.