Ankita Pathak, Head – Global Investments, Ionic Asset
After delivering a rate hike at its previous meeting, the ECB kept policy rates unchanged in July, reiterating its strong data-dependent approach. Despite subdued domestic economic growth, the central bank appears to remain firmly focused on bringing inflation under control. We believe and Lagarde signalled that the ECB is likely to prioritize inflation over growth in the near term, and therefore, the possibility of additional rate hikes cannot be ruled out. Within DMs while ECB and BoJ have chosen a path of policy tightening while the US Fed is on a pause mode, creating differentiated investment opportunities. A) investors are likely to remain overweight US equities where discount rate is stable and earnings have been more promising and B) An uptick of inflation in Eurozone and Japan carries a depreciative bias for these currencies which in turn translates into more strength in dollar. However, this trend could reverse if the ECB and BoJ continue to raise rates while Fed remains on a pause. DXY strength coupled and higher oil prices (both of which were perceived to be transitory at start of 2026) are creating anomalies across equity and bond markets.
In a much-anticipated move, the Governing Council kept the three key ECB rates unchanged, with the deposit facility rate at 2.25%, main re-financing rate at 2.40%, and the marginal lending rate at 2.65%. ECB delivered 25 bps rate cut in June 2026. With the conflict in the Middle East still ongoing, energy markets have continued to experience volatility in oil and gas prices, thereby weighing on the inflation outlook. ECB reiterated its commitment to bringing inflation back to its 2% medium-term target.
Economic Activity Improves Only Modestly, Growth Outlook Still Weighed Down By Energy Shock
Overall, economic activity showed some signs of improvement in the second quarter. The services sector has partly recovered driven mainly by AI related digital activity, while manufacturing held up on precautionary stock-building and higher defence spending. Unemployment level stayed low at 6.2%, however lower job postings point out to a weaker labour market ahead. With conflict still unresolved and energy prices volatile, the ECB’s projections show growth staying weak through early 2027, with GDP picking up only gradually from 0.8% in 2026 to 1.2% in 2027. Financing conditions have also tightened modestly since June’s hike, with stricter credit standards and softening mortgage demand, the intended channel through which the Central Bank aims to bring inflation back to target.
Inflation Moderates, But Remains Above 2%, Energy Risks Keep ECB in Wait And Watch
Headline inflation eased to 2.8% in June from 3.2% in May, with core inflation down to 2.4%. Inflation readings remain considerably above the Central Bank’s target of 2.0%, and is expected to stay elevated and is seen at 3.0% in 2026, and could potentially remain higher well into the first half of 2027 as the energy shock feeds through to food, goods, and services prices, before returning to the 2% target by 2028.
Markets Remain Under Pressure
European equities remained under pressure, with the STOXX 50 (-1.4%), CAC 40 (-1.6%), and DAX (-1.2%) trading lower. Meanwhile, the German 10Y Bund yield rose to 3.21%, while Brent crude remained elevated above USD 100/bbl, reflecting persistent geopolitical and energy market concerns
Disclaimer – This view is for educational and informational purposes only and should not be construed as an investment advice.
