The European Central Bank (ECB) reference interest rates have been at 2% since June. In the three subsequent meetings of the central bank board, rates have not been changed thanks to the unanimity that has formed around the pause proposal that has been put forward by Irishman Philip Lane, the central bank’s chief economist.
But beneath the unanimity of the 26 members of the council that decides monetary policy for the euro zone, there are two opposing views, reveal the minutes of the last meeting at the end of October published this Thursday. One group believes that the cycle of interest cuts, which supported the economy, “has come to an end”; the other argues that it is necessary to keep an “open mind” to the need to reduce interest rates further.
Despite these divergences, futures markets do not anticipate changes to the 2% rate either at the next meeting on December 17th or until the summer of 2026 at least. The probability of maintaining 2% in December is almost 100%. A change next year may only start to make sense in the second half of the year, with a 40% probability of new cuts.
Open or closed mind to more interest cuts?
What separates the two blocks is the assessment of how the risks that affect inflation may evolve.
For those who want an end to interest rate cuts, there are inflationary risks arising from the contagion of the impact of the Trump administration’s tariffs (customs fees), the worsening trajectory of public accounts in the euro zone, with the rise in deficits and debt levels, further disruptions in supply chains and the effects of extreme weather events.
According to the minutes, “in line with this strategic vision, as long as inflation expectations remain firmly anchored, the monetary policy stance should not be adjusted to respond to moderate and temporary fluctuations in inflation around the target [de 2%]but only if a significant deviation from the target is expected in the medium term.”
This bloc further argued that “it is doubtful that the [da política monetária] should be adjusted based on highly uncertain changes in political decisions, unless they have a significant impact on inflation expectations, which is unlikely.” In general, for this current, lower interest rates, implying “easier financial conditions can further fuel risk-taking in the financial system”.
For those who advocate an “open mind”, interest cuts may become justified if the pressure to reduce inflation below 2% increases. For these council members, the Chinese deflationary risk is important (with China strongly exporting part of its overproduction to the European Union at low prices) and the effects of volatility in financial markets with the high valuations of those listed on the New York stock exchanges could cause a contagion of crisis in Europe. The minutes also reveal that there is a new concern regarding financial risks: that the nexus between banks and sovereign debt crises (as occurred more than ten years ago) could be replaced by another, equally dangerous nexus between the non-bank financial system and debt crises.
Any decline in inflation, even if not significant, should not be ignored and should not preclude the need for a cyclical response. Inflation fell to 2.1% in October and forecasts point to it falling to 1.8% during 2026. In the technical language of central bankers, “tIt was also highlighted that the Governing Council’s monetary policy strategy, which requires appropriately vigorous or persistent monetary actions in response to large and sustained deviations of inflation from the target, does not imply that anything other than large and sustained deviations should be ignored or dispense with a cyclical monetary policy response to deal with demand-side shocks on an ongoing basis”.
With these two views in conflict, the commitment has been not to anticipate future decisions, not to commit the ECB to any of the paths, of lowering or raising interest rates, and maintaining a margin of maneuver of “total optionality”, highlight the minutes. Therefore, it became essential to analyze the concrete data and forecasts put forward by the ECB’s team of economists four times a year (March, June, September and December). At the next meeting, on December 17th and 18th, ECB members will analyze the macroeconomic forecasts from Philip Lane’s team.