Emeritus Professor Joe Nellis is Head of Economic Research at MHA, the accountancy and advisory firm.
The European Central Bank’s decision to leave its key interest rate unchanged at 2.5% is not a signal that interest rates have peaked. It instead reflects the increasingly tough balancing act the Bank faces as the Eurozone heads towards the end of a particularly challenging year. High inflation and sluggish economic growth mean it finds itself caught between the risks of tightening monetary policy too aggressively and allowing inflationary pressures to become entrenched. The Bank has decided to kick the can down the road for now, but a quarter-point rise looks increasingly likely at December’s meeting – with further increases expected in 2027.
Eurozone inflation rose to 3.8% in September, climbing 0.9 percentage points higher in two months, reflecting the continued impact of the Middle East Crisis on energy prices. However, it is becoming more likely that higher energy costs will feed into high wages pressures, pushing up the cost of services and consumer prices in general in the months ahead. These second-round effects will make it even harder for the ECB to control inflation and will force them to take interest rates even higher when it next meets.
To make matters worse, the outlook for economic growth across the EU remains subdued. The rising cost of energy is hurting household finances and weakening consumer confidence, while businesses are also having to grapple with rising operating costs, especially regarding transport. Financial markets are becomingly increasingly worried about the outlook for Europe – and bond yields have risen to reflect this sentiment, particularly in France.
The Eurozone will enter 2027 facing an uncomfortable combination of stubborn inflation, weak business investment and sluggish economic growth. While a rise in interest rates before the end of 2026 may help contain inflationary expectations to some extent, any tightening of monetary conditions by the ECB monetary policy will not resolve the underlying energy supply shock caused by external developments, meaning inflation is set to rise beyond 4% in the coming months.
