Today, the European Central Bank (ECB) Council unanimously decided to keep its three key policy rates on hold for the first time since lift-off in July 2022. This first pause follows 450 bps of hikes across ten consecutive meetings. The interest rate on the main refinancing operations, the marginal lending facility, and the deposit facility will remain at 4.50%, 4.75%, and 4.00%, respectively.

Markets and consensus forecasts had reached a near certain expectation of no policy rate move, and the ECB duly delivered no surprises. Today’s statement reiterated that “inflation is still expected to stay too high for too long,” which calls for maintaining a restrictive policy stance. The ECB’s goal remains to “ensure that inflation returns to its 2% medium-term target.”

The statement noted that “the Governing Council considers that the key ECB interest rates are at levels that, maintained for a sufficiently long duration, will make a substantial contribution to this goal.” This translates to a higher-for-longer policy backdrop and that restrictive levels have now been reached—suggesting ECB policy rates may have peaked. Accordingly, the ECB is starting to shift emphasis from “how high” the policy rate will rise, to for “how long” rates will remain at current levels.

Despite the softening in rhetoric, ECB President Christine Lagarde was unwilling to explicitly mark today’s pause as the end of its tightening cycle, stating instead that “today’s hold does not mean we will not hike again.” When a question about a peak rate was posed, she replied, “I am not going to make a judgement [around a peak rate],” reemphasizing that “we are data dependent.” President Lagarde also refused to state a particular inflation level, or length of time at which rate levels must remain before cuts could be contemplated. Conversations around rate cuts “are absolutely premature” and “forward guidance is inappropriate at this time.”

Since the September meeting, rising global bond yields have tightened financial conditions, while eurozone inflation has undershot economist forecasts and the ECB’s September projections. Nonetheless, inflation remains in focus, especially given oil price rises and the recent conflict in Israel. President Lagarde stated that “the euro area economy remains weak,” and rising growth risks further complicate the future policy rate path.

Euro-area inflation
Year-over-year % change, 2020–present

Euro-area headline and core inflation level since the start of 2020.

Source: Eurostat, European Central Bank, Bloomberg, Principal Asset Management. Data as of October 26, 2023.

No change to balance sheet operations

The ECB confirmed that balance sheet normalization (Quantitative Tightening, or QT), specifically the “APP portfolio is declining at a measured and predictable pace.” Since the September meeting, there has been some speculation for potential accelerated balance sheet reductions, but Council discussions on changes to QT appear postponed for now. Recent bond market volatility, especially the widening of spreads between German bunds and Italian sovereign bonds, likely contributed to this deferral. Despite wider periphery spreads, these are not yet suggestive of problematic policy transmission or fragmentation risks. Consequently, there was no change signaled for the reinvestment of PEPP principal payments “until at least the end of 2024.”

Markets muted on implicit ECB peak

The ECB will continue to weigh how much economic growth will need to be sacrificed to achieve its price stability mandate. Following the policy announcement, European sovereign bond yields declined modestly, together with a mildly weaker euro currency. These downward movements likely reflect the market's growing confidence that today's pause marks the end of ECB policy rate hikes for this cycle.

Outlook risks growing

Economic and inflation uncertainty remains elevated in the euro area. Policymakers must navigate a complex balancing act between weaker growth, elevated inflation, and geopolitical risks. Weaker growth suggests a limited scope for more hikes. However, after ten consecutive rate hikes totaling 450 basis points of tightening, and the slow descent of inflation, the ECB will have little choice but to maintain its policy rates higher-for-longer. With an emphasis on data dependence, the ECB will only more explicitly signal continued pauses to its rate hiking campaign once further disinflation developments become more evident.

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