ECB holds key interest rates steady, citing inflation above target and geopolitical risks

Underlying inflation pressures eased somewhat in June. Energy price inflation declined to 8.5 per cent, after 10.8 per cent in May, while inflation excluding energy and food eased to 2.4 per cent, from 2.6 per cent in May. Services inflation decreased from 3.5 per cent to 3.2 per cent, a modest but notable shift that officials said was consistent with a gradual moderation in price growth.

Inflation still above target into 2027

Even with these declines, the ECB stressed that price pressures are not yet contained. "Its rise since the start of the conflict - and its impact on food, goods and services price inflation - is likely to keep inflation well above target into the first half of 2027," the statement said, projecting a subsequent decline as energy prices are expected to fall. "We are committed to setting monetary policy to ensure that inflation stabilises at our two per cent target in the medium term."

Risks to the outlook, the Governing Council said, remain tilted upward. "The risks to the inflation outlook are to the upside," the statement noted, pointing to factors including ongoing trade tensions, which "could give rise to more fragmented global supply chains, curtail the supply of critical raw materials and worsen capacity constraints in the euro area economy." Extreme weather events, including ongoing heatwaves, could also push food prices higher than expected.

Geopolitical risks shape the outlook

Geopolitical developments featured prominently in the council's risk assessment. "Other geopolitical tensions, in particular Russia's unjustified war against Ukraine, remain a major source of uncertainty," the statement said. Officials also pointed to the Middle East, noting that "the Memorandum of Understanding agreed between the United States and Iran in June constituted a first attempt to resolve the conflict." Even so, "the conflict in the Middle East remained a headwind" to activity in the second quarter.

On the real economy, recent indicators were mixed but slightly more positive. "Recent information points to some improvement in economic activity in the second quarter," the statement said, helped by services activity that "has partly recovered, after weakening markedly in the immediate aftermath of the energy shock." Digital services have been "robust, in part owing to the increasing contribution from AI-related activity," and manufacturing "has continued to hold up, supported by firms building up stocks to guard against supply chain risks, as well as by higher defence spending."

Labour market and financial conditions

The labour market remained resilient but is showing signs of cooling. "Unemployment stood at 6.2 per cent in May, close to historical lows," the statement said, while warning that "job postings have continued to decline and both firms and households expect the labour market to remain weaker than before the conflict." Bank lending rates for firms remained at 3.6 per cent in May. The ECB's wage tracker "continue[s] to indicate moderate wage growth over the coming quarters," and "most measures of longer-term inflation expectations stand at around 2 per cent."

Financial conditions tightened slightly since the previous meeting. "Overall financial conditions have become slightly tighter since our previous meeting, consistent with the increase in the key ECB interest rates," the statement said, a sign that previous rate moves are continuing to feed through to borrowing costs and credit availability. Officials reiterated a call for "fiscal responses to the energy shock" to be "temporary, targeted and tailored," and urged "urgent action to strengthen the euro area economy while maintaining sound public finances."

Digital euro advances

On the digital euro, the council welcomed progress in the legislative process. "The positive vote in the European Parliament earlier this month was a significant milestone on the path to establishing the digital euro," the statement said, adding that the ECB, EU Council and Commission share the objective of "reaching agreement by the end of this year on the Single Currency Package."

In closing remarks, Lagarde reiterated that future decisions will hinge on incoming data, with no preset course for rates. "We will follow a data-dependent and meeting-by-meeting approach to determining the appropriate monetary policy stance," she said, underscoring that the bank is prepared to act if inflation proves more persistent than expected, or to ease if price pressures fade more quickly.