ECB Holds Steady — But Don’t Call It Quiet: Why the Euro’s Strength and Falling Inflation Have Policymakers on Edge

CNBC, Bloomberg, the Financial Times, and European Central Bank contributed to this report.

The European Central Bank pressed pause at its first meeting of 2026 — leaving policy rates unchanged and sticking with a meeting-by-meeting approach. That sounds dull, until you look under the hood: a stronger euro, cooling inflation and a fragile global backdrop mean this “hold” is actually packed with watching, weighing and quietly worrying.

The ECB kept its three main rates where they were: deposit facility 2.00%, main refinancing operations 2.15% and marginal lending facility 2.40%. The Governing Council said inflation should stabilise around its 2% target over the medium term and that the economy still looks resilient — low unemployment, decent private-sector balance sheets and fresh public spending on defence and infrastructure are helping. But the bank also flagged uncertainty from trade tensions and geopolitical risks, and President Christine Lagarde stressed the policy will stay “data dependent” and evaluated “meeting by meeting.”

On the surface, a hold is headline fodder. But economists say the February decision is far from a non-event. The big reason: the euro’s recent run-up has started showing up on the bank’s radar as a potential headwind to inflation. Over the past month the currency has strengthened roughly 0.75% against the dollar and has leapt nearly 14% over the past year. For an inflation-targeting central bank, a stronger currency is effectively free disinflation — imported goods, raw materials and energy become cheaper, and that can drag price growth down.

That matters because the eurozone’s flash January inflation print already cooled to about 1.7% — below the ECB’s 2% target. Deutsche Bank economists pointed out that, “all else unchanged, the recent appreciation is disinflationary and reinforces the expected inflation undershoot.” In plain English: the euro could do some of the ECB’s tightening for it — and that’s not always a good thing.

Policymakers aren’t panicking, but they’re scanning for two-sided risks. On the downside: a stronger euro, coupled with weaker global demand, could push inflation lower than expected, risking real economic stagnation if it becomes persistent. A rapid and sustained move in the currency or a slowdown in growth indicators would change the calculus fast.

On the upside: domestic forces — tight labour markets, rising domestic demand, and fiscal easing from some governments — could push inflation back up. Deutsche Bank’s base case is that the ECB can sit on 2% through 2026 and only contemplate hiking in mid-2027 if domestic pressures keep building. That’s a slow-burn scenario, but not impossible.

Lagarde reiterated the bank won’t pre-commit to a path.

“In particular, our interest rate decisions will be based on our assessment of the inflation outlook and the risks surrounding it,” she said.

French central bank governor François Villeroy de Galhau publicly warned that the euro’s rise could have implications for lower inflation. And S&P Global’s Sylvain Broyer said the ECB could “keep the autopilot on this time,” noting that financing conditions remain supportive and growth is outperforming expectations.

Markets and economists are watching three things closely: the pace and persistence of the euro’s appreciation, incoming growth data, and the next set of ECB projections (due next month). Greg Fuzesi at JPMorgan pointed out that the ECB watches not just the level of the currency but how fast it’s moving and whether the change looks like it will stick — and for now, he says, “none of this looks overly troubling.”

The ECB isn’t helpless. Besides standard rate adjustments, it reaffirmed that it can use all its instruments, including the Transmission Protection Instrument, to counter disorderly market conditions that threaten policy transmission across member states. The bank also continues to let its asset purchase portfolios run down at a measured pace, not reinvesting maturing principal — a subtle way of withdrawing support without sudden shocks.

Currency strength acts like an invisible interest-rate cut. Cheaper imports cool headline inflation, which is great for consumers in the short term but tricky for a central bank trying to hit a 2% target. If the euro keeps climbing and inflation keeps undershooting, the ECB risks getting stuck in a low-inflation trap where monetary policy becomes less effective and political pressure mounts for fiscal fixes.

Most economists think the ECB will sit tight for the rest of 2026 — Reuters’ January poll found about 85% expected no further rate moves this year. Still, the situation is fluid: a faster-than-expected euro rally, a sharp growth slowdown, or fresh external shocks could force the Council to act sooner (either easing or tightening, depending on direction). Deutsche Bank’s scenario — hold through 2026, hike in mid-2027 if domestic inflation pressures reappear — is the safe, middle-ground forecast right now.

The ECB’s decision to keep rates steady was expected — but don’t mistake expectation for insignificance. The bank is juggling a stronger euro, signs of cooling inflation and mixed domestic momentum. That makes this “hold” a carefully calibrated pause: the ECB is ready to pivot, with its eyes fixed on currencies, incoming data and the tug-of-war between external disinflation and domestic inflationary pressures. In the world of central banking, sitting still can be the most active move of all.