Account of the monetary policy meeting of the Governing Council of the European Central Bank held in Frankfurt am Main on Wednesday and Thursday, 23-24 July 2025
1. Review of financial, economic and monetary developments and policy options
Financial market developments
Ms Schnabel started her presentation by noting that financial markets had reverted to a low-volatility, "risk-on" regime, leaving the turbulence of April 2025 behind despite further tariff-related headlines. Market volatility had receded after the short-lived spike due to tensions in the Middle East, with tariff announcements by the US Administration having recently lost traction as drivers of asset price dynamics and risk assets having rallied globally since the Governing Council's last monetary policy meeting on 4-5 June. Meanwhile, the euro area economy appeared to be more resilient to rising tariffs and elevated trade uncertainty than anticipated. Despite a further appreciation of the euro, driven to a large extent by the reassessment of relative economic activity between the euro area and the United States, market-based inflation compensation had edged up further and the ECB forward interest rate curve had shifted higher.
In the United States, a decoupling of market volatility from economic policy uncertainty had been observed, even more than during Mr Trump's first presidential term. Markets were increasingly "looking through" tariff announcements. One explanation as to why they were taking a more benign view of tariff threats and elevated uncertainty lay in the fact that in the euro area, and lately also in the United States, macroeconomic data had surprised on the upside, indicating that the economy was more resilient than initially expected. Euro area GDP growth forecasts had held up well over recent months. Some private sector forecasts for euro area real GDP growth in 2025 and 2026 stood near the levels that had prevailed ahead of the initial US tariff announcements in April and continued to point to a gradual recovery, with growth expected to gain further momentum in 2027. For the United States, by contrast, growth forecasts from these surveys had been significantly downgraded for 2025 and 2026, and stood well below 2024 levels.
The reassessment of relative growth expectations between the euro area and the United States was also evident in equity markets. The US S&P 500 index had reversed part of its recent underperformance, while remaining for the year to date well below the euro area benchmark index, and especially the German DAX which had been boosted by the country's fiscal package. Stocks of smaller US firms had only just returned to the level reached at the start of the year and had significantly underperformed their counterparts in the euro area
The reassessment of the euro area growth outlook had also led to a reappraisal of market-based inflation compensation. Investors had revised up their 2025 and 2026 forecasts for inflation as measured by the Harmonised Index of Consumer Prices (HICP) excluding tobacco relative to expectations at the time of the Governing Council's previous monetary policy meeting. Inflation fixings stood at their highest level since March for most of 2026, well above the levels seen at the time of the April and June monetary policy meetings. For 2025, they stood below March levels, owing to lower energy prices. Both growth and inflation expectations were thus currently back to, or even above, pre-April levels. While the euro's appreciation had dampened inflation expectations, this effect had been more than offset by a recovery in energy prices.
Ms Schnabel then reviewed recent EUR/USD exchange rate developments. Since the Governing Council's meeting on 3-5 June the euro had continued to appreciate against the US dollar, a trend that had begun with the announcement of the German fiscal package in early March. The euro was currently trading close to its average of USD 1.18 over the period since its inception in 1999, and around 4% above its average of USD 1.12 over the past decade. The key driver behind the euro's recent appreciation against the US dollar been a positive relative demand shock, as reflected in the upward revisions to the euro area's economic outlook relative to the US outlook, suggesting a relatively small pass-through of the exchange rate to inflation. Over the past few months there had been a rise in demand for protection against euro strength or US dollar weakness, particularly from euro area investors seeking to hedge their US dollar exposures amid perceived risks of a further depreciation of the US dollar.
The combination of a resilient economy, higher market-based inflation expectations and ECB communication that it was "in a good place" had led to a reassessment of the expected monetary policy path of the ECB, and the overnight index swap forward curve had shifted up. Markets were pricing in one further 25 basis point cut in policy rates by the end of 2025, with the forward curve starting to rise again in the second half of 2026. Market expectations for 2025 stood above median expectations reported in the Survey of Monetary Analysts.
Global investors had continued to take a positive view of euro area sovereign bond markets. Euro area sovereign spreads over German Bunds, which had narrowed in the wake of the threat of higher tariffs, had remained broadly unchanged at low levels since the last monetary policy meeting. Over recent weeks the focus in sovereign bond markets had shifted to the very long end of the curve. In the United States, the United Kingdom and Japan, 30-year bond yields, which were particularly sensitive to debt sustainability risks, had been on a persistent upward path since late 2022. Euro area yields had remained comparatively stable and close to their average level since the end of 2022. One key factor insulating euro area long-term yields from global upward pressures was the region's stronger fiscal position relative to other economies.
The reassessment of relative growth prospects as well as broader concerns about the United States and its fiscal trajectory had led to incipient signs of a rebalancing in global investment flows. Non-US-domiciled investment funds, which had been steadily acquiring US equities throughout 2024, had sharply reduced their purchases as of April 2025. Moreover, foreign investors had shifted into the euro area at a stronger than average pace.
Rising risk appetite globally had benefited corporate bond markets, with corporate bond spreads narrowing across market segments and regions. Empirical analysis indicated that the surge in euro-denominated issuance by US firms was linked to rising US economic policy uncertainty. At the same time, relative yields had continued to play an important role in investors' reallocation of funds into different global sovereign bond markets, benefiting euro area government bonds. However, structural challenges continued to weigh on the euro area's attractiveness as its government bond markets lacked the depth and liquidity of the US Treasury market.
Finally, regarding recent developments in money markets, since 2022 excess liquidity had been gradually reduced to around €2.6 trillion. As excess liquidity, but also collateral scarcity, had declined, money market rates had started to edge higher. While the euro short-term rate remained below the deposit facility rate, the gap had narrowed. Repo rates were trading very closely around the deposit facility rate for both general and non-general collateral.
The global environment and economic and monetary developments in the euro area
Starting with inflation developments in the euro area, Mr Lane noted that inflation was currently at the Governing Council's 2% medium-term target. It had edged up to 2.0% in June from 1.9% in May, mainly on account of a rise in energy inflation to -2.6% from -3.6%. Food inflation had eased slightly, to 3.1% from 3.2%. Core inflation (HICP inflation excluding energy and food) had been unchanged at 2.3% in June, since a 0.1 percentage point increase in services inflation to 3.3% had been broadly offset by a 0.1 percentage point decline in goods inflation to 0.5%.
Indicators of underlying inflation were consistent overall with the 2% medium-term target. Growth in compensation per employee had fallen further in the first quarter of the year, to 3.8%, from 4.1% in the last quarter of 2024. Combined with stronger productivity growth, this had resulted in slower growth in unit labour costs. In line with the June 2025 Eurosystem staff macroeconomic projections for the euro area, the ECB wage tracker pointed to lower wage growth in the coming quarters, while survey-based expectations of firms, consumers and professional forecasters all pointed to further declines also in 2026. In turn, the deceleration of wage growth would support the deceleration of services inflation.
Taking into account recent energy futures prices, headline inflation was expected to fluctuate around its current level for the remainder of 2025, before reaching a trough of around 1.5% in the first quarter of 2026. Relative to the June baseline projection, this implied a slightly smaller near-term shortfall from the inflation target owing to the upward movement in energy prices. According to the July round of the Survey of Monetary Analysts and the latest round of the Survey of Professional Forecasters, expectations regarding headline inflation were broadly in line with the June staff projections, except that these surveys pointed to a milder inflation undershoot of between 0.1 and 0.2 percentage points below target in 2026. That was less than the 0.4 percentage point undershoot foreseen in the June projections. Short-term consumer inflation expectations had declined in both May and June according to the Consumer Expectations Survey, reversing the uptick observed in previous months. There had also been a decline in the short-term inflation expectations of firms reported in the latest survey on the access to finance of enterprises. Most measures of longer-term inflation expectations continued to stand at around 2%, supporting the stabilisation of inflation around the Governing Council's target. But market-based measures of inflation compensation indicated an inflation path below 2% over the next four years.
With respect to the external environment, the global composite Purchasing Manager's Index (PMI) excluding the euro area had edged down on average in the second quarter, to 51.4, from 52.0 in the first quarter, reflecting declines in both manufacturing and services. Incoming data suggested a reduction in global import growth in the second quarter after the substantial frontloading observed in the first quarter in anticipation of higher tariffs. Although higher tariff rates had the potential to reshape global trade flows and might pose challenges for logistics, global supply chain pressures remained contained according to the available data and to participants in the latest Corporate Telephone Survey.
The euro had appreciated against the US dollar by 2.5% since the June Governing Council meeting and by 4.0% since the cut-off date for the June Eurosystem staff projections. In nominal effective terms, it had appreciated by 1.9% since the June Governing Council meeting and by 2.6% since the June projections. Brent crude oil prices had increased by 6% since the June Governing Council meeting and had experienced pronounced volatility linked to tensions in the Middle East. Compared with the levels at the time of the June Governing Council meeting, oil futures prices had increased over the full projection horizon, especially at the front end of the curve. Compared with the June projections, the futures curve stood 5% higher by the end of 2026 and 3% higher at the end of 2027. By contrast, European gas prices stood 6% lower than at the time of the June projections, but gas futures were slightly higher in 2027.
Partly reflecting the Governing Council's past interest rate cuts, the euro area economy had so far been resilient overall in a challenging global environment. In the first quarter of 2025 the economy had grown by more than expected. This had been supported by a frontloading of exports ahead of expected tariff hikes, especially in the Irish pharmaceutical sector. Private consumption and investment had also made a positive contribution to growth, while inventories had made a negative contribution.
There were signs that some manufacturing subsectors were continuing to frontload activity following the postponement of US tariff decisions. The manufacturing output PMI for the euro area had increased on average in the second quarter, to 51.3, from 48.8 in the first quarter, signalling a quarterly expansion for the first time in three years. But forward-looking PMIs for new orders and new export orders for the manufacturing sector suggested only a stabilisation in the level of activity rather than a substantial expansion. The services PMI and the composite output PMI pointed to a modest pace of growth. Overall, and as expected, incoming information continued to suggest a moderation in economic activity as uncertainty remained elevated. Although the latest data had shown some improvement from the April dip, the still subdued level of consumer confidence was likely to hold back private consumption expenditure in the short term. Higher actual and expected tariffs, the stronger euro and persistent geopolitical uncertainty were also making firms more hesitant to invest.
At the same time, prospects for domestic demand continued to be supported by a number of factors. Easier financing conditions were underpinning both housing and business investment. Consumption continued to benefit from rising real incomes, solid private sector balance sheets and the robust labour market. Over a longer horizon higher public investment in defence and infrastructure should also support growth.
The unemployment rate had remained little changed over the past year and had stood at 6.3% in May. Employment had grown by 0.2% in the first quarter, up from 0.1% in the fourth quarter of 2024. As real GDP growth had picked up relative to employment growth, productivity had improved, both per hour and per worker. At the same time, employment PMIs remained subdued and job postings had declined, pointing to a continued gradual softening in demand for labour.
As regards trade, the recent appreciation of the euro was weighing on the competitiveness of euro area firms, both in terms of exporting and in terms of matching cheaper imports in the domestic market. China's price competitiveness had improved further and imports from China had grown significantly since the start of the year. This suggested some diversion of trade to the euro area, as also indicated by corporate contacts, but might in addition reflect the sourcing of intermediate inputs to frontload euro area exports.
Risks to economic growth remained tilted to the downside. Among the main risks were a further escalation in global trade tensions and associated uncertainties, which could dampen exports and drag down investment and consumption. A deterioration in financial market sentiment could lead to tighter financing conditions and greater risk aversion, and make firms and households less willing to invest and consume. Geopolitical tensions, such as Russia's unjustified war against Ukraine and the tragic conflict in the Middle East, remained a major source of uncertainty. By contrast, if trade and geopolitical tensions were resolved swiftly, this could lift sentiment and spur activity. Higher defence and infrastructure spending, together with productivity-enhancing reforms, would add to growth. An improvement in business confidence would also stimulate private investment.
The outlook for inflation was more uncertain than usual, as a result of the volatile global trade policy environment. A stronger euro could bring inflation down further than expected. Moreover, inflation could turn out to be lower if higher tariffs led to lower demand for euro area exports and induced countries with overcapacity to re-route their exports to the euro area. Trade tensions could lead to greater volatility and risk aversion in financial markets, which would weigh on domestic demand and would thereby also lower inflation. By contrast, inflation could turn out to be higher if a fragmentation of global supply chains pushed up import prices and added to capacity constraints in the domestic economy. A boost in defence and infrastructure spending could also raise inflation over the medium term. Extreme weather events, and the unfolding climate crisis more broadly, could drive up food prices by more than expected.
Since the Governing Council's previous meeting, financial markets had experienced some volatility amid a temporary escalation of geopolitical tensions and ongoing trade uncertainty. Market interest rates had increased since the previous meeting, especially for longer maturities. At the same time, the Governing Council's past interest rate cuts continued to make corporate borrowing less expensive. The average interest rate on new loans to firms had declined to 3.7% in May, from 3.8% in April. The cost of issuing market-based debt had also come down, falling to 3.6% in May. The average interest rate on new mortgages had barely changed since the start of the year and had stood at 3.3% in May.
Credit dynamics remained subdued overall. The growth rate of loans to firms had moderated to 2.5% in May. However, corporate bond issuance was stronger, growing at a rate of 3.4% in annual terms. According to the latest bank lending survey for the euro area, firms' demand for loans remained weak overall against the backdrop of global uncertainty and trade tensions, despite a slight pick-up owing to lower interest rates. The picture of a broadly unchanged supply of credit to firms and overall weak loan demand reported by banks in the bank lending survey was broadly consistent with the developments reported by firms in the latest survey on the access to finance of enterprises. Subdued loan demand also fitted with the "wait-and-see" approach to investment reported by firms in the Corporate Telephone Survey. Growth in mortgage lending had, however, edged up to 2.0% in May, from 1.9% in April, amid a strong increase in demand.
According to the bank lending survey, credit standards for business loans had been broadly unchanged in the second quarter, following two consecutive quarters of tightening. While banks' concerns about the economic risks faced by their customers had had a tightening impact on credit standards, this had been broadly offset by stronger competition among lenders. Credit standards for mortgages had tightened slightly in the second quarter.
