ECB Sees End of Tightening Cycle Amid Weakening Growth Outlook

The European Central Bank (ECB) appeared poised to keep interest rates unchanged throughout 2026, following a successful disinflation process that saw inflation fall close to its 2% target. However, the escalation of the US-Iran conflict led to severe supply disruptions and constraints on shipping through the Strait of Hormuz, triggering a sharp increase in oil and natural gas prices.

This pushed inflation above target once again, prompting policymakers to raise their deposit rate by 25 basis points in June to prevent what was initially viewed as a temporary energy shock from becoming a broader inflation problem. The ECB's decision has been met with cautious optimism, with some analysts arguing that the move was an appropriate response to the temporary inflation risks.

One key factor supporting this assessment is the easing of inflation risks that prompted the June rate hike. Recent data suggest that higher energy costs are not feeding broadly into the economy, and euro inflation swap rates, a market-based measure of investors' inflation expectations, have fallen below the ECB's 2% target over the next year.

Furthermore, the weakening growth outlook for the Euro Area reinforces the case for no further increases in policy rates. Business activity has remained subdued, with the composite Purchasing Managers' Index (PMI) staying below the 50-point threshold that separates expansion from contraction for the past three months.