ECB Holds Rates at 2% and Signals Its Yearlong Cutting Cycle Is Likely Over

FRANKFURT, Germany — The European Central Bank left interest rates unchanged on Dec. 18 and signaled that, barring new shocks, its yearlong round of cuts is over as inflation edges back toward its goal.

After a meeting at its Frankfurt headquarters, the ECB’s Governing Council kept its three key rates steady, holding the deposit facility at 2.0%, the main refinancing rate at 2.15% and the marginal lending facility at 2.40%. It was the fourth consecutive on-hold decision since June, when the bank last reduced borrowing costs.

“The Governing Council today decided to keep the three key ECB interest rates unchanged,” President Christine Lagarde said at a news conference. The central bank’s updated assessment, she added, “reconfirms that inflation should stabilise at our two per cent target in the medium term.”

The apparently uneventful decision marks a turning point. After lifting rates from below zero to roughly 4% in 2022 and 2023 to fight a post-pandemic surge in prices, and then cutting them in several steps starting in mid-2024, the ECB now judges that policy is “in a good place”—neither so tight as to choke off growth nor so loose as to reignite inflation.

Officials are also stepping back from signaling any clear path for borrowing costs. “With the degree of uncertainty that we are facing, we simply cannot offer forward guidance,” Lagarde said. She stressed that future moves would be “data-dependent” and decided “meeting by meeting,” language traders took as a mild warning that rate increases remain possible if inflation proves more stubborn than expected.

Inflation near target, but not quite there

New projections released alongside the decision show inflation hovering close to, but not exactly at, the ECB’s 2% target for several years.

Central bank staff now forecast that consumer prices in the 20-nation euro area will rise by an average of 2.1% in 2025, 1.9% in 2026 and 1.8% in 2027, before returning to 2.0% in 2028. Excluding volatile energy and food, inflation is seen at 2.4% next year, slowing to 2.2% in 2026, 1.9% in 2027 and 2.0% in 2028.

Part of the dip below 2% in the middle of the forecast horizon reflects the fading impact of past energy price spikes. At the same time, the bank expects a renewed increase in energy-related inflation toward the end of the decade, including from the European Union’s expanded Emissions Trading System for fuels used in road transport and buildings, known as ETS2. Staff estimate that ETS2 could add around 0.2 percentage point to headline inflation in 2028.

Despite that technical bump, price pressures in the services sector—which are closely tied to wages—remain the main concern.

Eurostat data show services inflation running at roughly 3.5% in November, even as headline inflation hovered near 2%. Lagarde said wage developments had been stronger than the ECB anticipated.

“Wages have surprised us to the upside,” she told reporters. “We anticipate that wages will follow a slightly declining trend going forward.”

Staff projections point to unit labor cost growth—a key measure of how pay feeds into prices—easing from 3.3% in 2025 to 2.6% in 2026 and about 2% in 2027 and 2028. Unemployment in the eurozone stood at 6.4% in October, close to historic lows, suggesting companies may continue to face pressure to raise pay even as the economy slows.

Growth revised up, driven by domestic demand and AI

The ECB also upgraded its outlook for economic growth. It now expects real gross domestic product in the euro area to expand by 1.4% in 2025, 1.2% in 2026 and 1.4% in both 2027 and 2028, modestly higher than its previous projections.

Lagarde said the revisions reflected “some resilience of domestic demand,” helped by improving real incomes, still-solid labor markets and easing financial conditions after last year’s rate cuts. She highlighted an emerging driver of investment: artificial intelligence.

According to Lagarde, AI-related spending on computing power, telecom networks, software and data infrastructure has become a notable source of capital formation, not only among large corporations but also small and midsize enterprises. However, she cautioned against drawing firm conclusions about how such structural shifts affect the so-called neutral interest rate—the level of borrowing costs that neither stimulates nor restrains the economy—saying the subject was not a focus of this meeting.

National central banks broadly share the picture of a gradual recovery with lingering price pressures. The German Bundesbank, for example, recently projected that Europe’s largest economy will grow just 0.2% in 2025 and 0.6% in 2026 after several years of stagnation, while revising up its forecasts for wages and core inflation.

Out of sync with the Fed and Bank of England

By holding rates steady and avoiding any hint of further cuts, the ECB is diverging from several of its peers.

The Bank of England on the same day lowered its key rate to 3.75%, its lowest level in nearly three years, as it tries to support a weakening labor market. The U.S. Federal Reserve has been reducing rates through 2025 and investors expect additional steps in 2026, amid signs of cooling inflation and growth.

Market pricing around the ECB decision suggested that traders saw almost no chance of further cuts next year and placed a small probability on rate increases toward the end of 2026 or in 2027. The euro ticked higher against the dollar after the announcement and is on track for a double-digit annual gain, helped by narrowing interest-rate differentials and improved sentiment about the euro-area economy. Long-term eurozone bond yields moved only modestly, with a slight steepening of the curve as investors reconsidered the likelihood of deeper easing.

The ECB, meanwhile, is continuing to unwind the large bond portfolios it built up during years of quantitative easing. Holdings under its regular asset purchase program and the pandemic emergency program are shrinking as the bank no longer reinvests maturing securities, a process officials say is proceeding at a “measured and predictable pace.”

The central bank’s Transmission Protection Instrument, a backstop introduced in 2022 to counter unwarranted spikes in borrowing costs for individual member states, remains in place but has not been activated.

Households, banks and governments adjust to a new normal

For households, the pause at a 2% deposit rate locks in the lowest borrowing costs since late 2022 after the sharp run-up in mortgage and consumer loan rates during the tightening phase. The relief is particularly visible in countries with heavily indebted households and variable-rate mortgages, such as Spain and the Netherlands.

At the same time, savers continue to benefit from positive nominal returns on deposits after years in which many bank accounts paid zero or negative interest. Banks, for their part, have seen net interest margins stabilize at favorable levels, and a steadier rate outlook has reduced swings in the market value of their bond portfolios.

Governments also stand to gain from clearer financing conditions. With 10-year, euro-area sovereign borrowing costs clustered around 3%, finance ministries face less pressure from rising debt-servicing costs as they increase spending on defense, infrastructure and climate projects, and as the European Union debates new joint instruments to support Ukraine’s reconstruction and bolster security.

Lagarde, however, again underscored that fiscal policy must remain sustainable. She urged governments to pair “strategic investment” with “growth-enhancing structural reforms,” signaling that the ECB is not prepared to underwrite unlimited deficits.

Ukraine, the digital euro and the ECB’s limits

Questions at the news conference highlighted how monetary policy is intersecting with broader European debates.

Pressed about EU plans to tap frozen Russian central bank assets or their profits to help finance a loan package for Ukraine, Lagarde said she was “fully confident” that European leaders would reach an agreement because the issue was too important to leave unresolved. But she stressed that any scheme must comply with European treaties and international law.

The ECB, she said, could not support arrangements that would breach Article 123 of the Treaty on the Functioning of the European Union, which prohibits direct monetary financing of governments.

Lagarde also used the occasion to promote the planned digital euro, which would be a public, electronic form of central bank money. She described it as “a currency that is the anchor of stability for the financial system” in a digital age, insisting the project was about safeguarding monetary sovereignty rather than following technological fashion. Technical work at the ECB is largely complete, she said, and it is now up to the European Parliament and Council to finalize the legal framework.

She linked the initiative to a broader push for completing the banking union and building what she called a “savings and investments union,” an expanded version of the EU’s capital markets union aimed at channeling more private capital into European companies.

A fragile equilibrium

The ECB’s decision to hold rates steady caps a rapid transition from emergency stimulus, to record-fast tightening, to a calmer plateau near what many economists see as a more “normal” level for European interest rates.

That equilibrium rests on a delicate balance: inflation must continue to ease without growth stalling, wages must moderate without a spike in joblessness, and geopolitical shocks must not derail energy markets or trade. By refusing to pre-commit and insisting decisions will be taken one meeting at a time, Lagarde and her colleagues are trying to preserve room to maneuver.

Whether the current 2% setting proves durable will depend less on models than on events. In an economy still adjusting to an energy shock, an AI investment surge and a war on its borders, the real test of the ECB’s new steadiness is likely still ahead.