ECB rate cut cycle most likely over

Eurozone Q2 GDP unrevised at 0.1%; solid consumption likely offset tariff shock

The 2nd estimate of Q2 GDP was released this morning, and headline growth was unrevised from the 1st estimate at 0.1% q/q. We still do not have the expenditure breakdown, but with industrial production revised down in May and coming in weak in June, we suspect that net exports were revised down on the back of the unwind of US export frontloading, but that this was offset by consumption, which is coming in stronger. The full details will be released with the 3rd estimate of Q2 GDP on 5 September. We will update our growth forecasts in our Global Monthly publication, released next week.

ECB “in a good place” – we now expect rates to stay on hold

Despite the US tariff shock, the eurozone economy is exhibiting underlying resilience, and this is giving the ECB room to take a wait and see approach. Consistent with President Lagarde’s repeated remarks that policy is ‘in a good place’, we think that the ECB will likely keep its key policy rates on hold over the coming months, with the deposit rate staying at 2%. This represents a change to our previous base case that there would be another 50bp of rate cuts. Our view that there would be further rate cuts was based on the outlook for a prolonged period of below-target inflation, which could potentially be extended by further declines in oil prices, euro strength and global goods price disinflation. However, the recent communication from the Governing Council suggests it is happy to look through this on the basis that inflation will eventually return to target during 2027. Although the ECB’s inflation projection factored in a 25bp rate cut (as it was based on market rate expectations at the time), we doubt the Governing Council is minded to fine tune to that degree.

In addition, even if the period of disinflation proves more prolonged that it currently expects, it will probably continue see inflation back to target over the medium term. The exception is if there were to be a significant growth shock, which sees the economy weakening for a more significant period than the ECB currently projects. Of course, with US import tariffs having risen above the ECB’s current baseline for both the EU and the rest of the world, that is clearly a possibility. However, fiscal stimulus from Germany will likely (increasingly) offset the drag from trade. Indeed, it is important to note that the ECB factored in only modest fiscal stimulus in its June base case, and its economists will likely upgrade government spending in the new forecast in September. In our own base case, although we are expecting a significant drag on net exports, this is increasingly offset by fiscal stimulus, with growth returning to trend later in the year and in 2026. We therefore now see interest rates remaining where they are through our forecasting horizon. The ECB view change by itself implies a somewhat higher EUR/USD forecast, but uncertainty around the Fed path right now means we prefer to keep our FX forecasts unchanged for now.