We think risks to the ECB’s inflation forecast are to the upside. Though we expected the impact of US tariffs to be manageable, the economy has proven even more resilient than expected. Output in the eurozone grew at an annualised pace of 1.5% during the first half, above the ECB’s expectations for growth of 1.2% year-on-year for 2025 as a whole – and recent PMI surveys indicate this strength has persisted.
Fiscal policy in the euro area will also be substantially looser in coming years. This is primarily down to Germany’s stimulus package, which could lift GDP in the region by around 0.5% over the next two to three years.
Finally, the dampening impact on inflation from the stronger euro is likely to be limited. So far, most of the strength in the euro has been for ‘good reasons’ - a reassessment of the relative growth prospects in the euro area rather than a destabilising dollar sell-off. This typically limits the exchange rate passthrough to consumer prices.
Against a backdrop of a still-tight labour market, these risks could prompt the ECB to raise its inflation projections in December or March. On the ECB’s Governing Council, the balance of opinion may already be shifting.
Given markets have priced a cumulative 10bp of ECB cuts by June next year, and Capital Group’s CSR team expects the Federal Reserve to be cutting rates, our forecast of two rate hikes by the ECB points to upward pressure on Bund yields and the euro in the coming months.
