ECB's Tightening Cycle May Be Coming to an End

The European Central Bank (ECB) had initially planned to keep interest rates unchanged throughout 2026. However, the escalation of the US-Iran conflict in early 2026 led to a sharp rise in oil and natural gas prices, pushing inflation above target again.

As policymakers became increasingly concerned that higher energy costs could spill over into other goods and services, making inflation more persistent through second-round effects, the ECB raised its deposit rate by 25 basis points in June. This decision was seen as an appropriate response to the temporary inflation risks.

Recent data suggests that the inflation shock is likely to prove temporary, with both headline and core inflation surprising to the downside in June. Additionally, euro inflation swap rates have fallen below the ECB's 2% target over the next year, further weakening the case for further monetary tightening.

The ECB's Governing Council has emphasized a data-dependent approach, without pre-committing to a specific path for policy rates. This suggests that policymakers are becoming more comfortable with leaving interest rates unchanged. The reduced need for additional monetary tightening is also supported by a weaker growth outlook and recent communication from the ECB.