Why the ECB has kept its interest rates unchanged

Since June 2024, the ECB has gradually lowered its key policy rate from 4% to 2%. A 4% interest rate was needed to get a grip on excessive inflation in the 2021-2024 period in the euro area (read here: how interest rates and inflation interact). Thanks in part to the ECB’s policy, inflation fell back towards the target level in the course of 2024, and interest rates could be lowered again. Now the ECB is keeping its interest rates unchanged. What were its considerations for doing so?

Has the inflation target been achieved?

Euro area inflation stood at 2% in June 2025, the ECB's inflation target. Core inflation – inflation excluding the often highly volatile prices of energy and food – has also been falling for some time and is approaching 2%. Recent figures thus confirm that price pressure is easing. At the same time, the economy is holding up reasonably well despite the global turmoil. 

This appears to be good news. Still, looking ahead, the inflation picture remains surrounded by risks, and the question is whether inflation will remain at 2% also in the somewhat longer term. On the one hand, there are factors that can drive up inflation. For example, higher government spending, weather events such as heat waves, but also rising tensions in the Middle East that could fuel price pressure through higher energy prices. On the other hand, there are factors that could actually cause inflation to fall, such as weaker global demand due to US import tariffs on EU products. Moreover, high US tariffs on China may result in Chinese goods being pushed  into the euro area at lower prices, which also has a lowering effect on inflation.

The high degree of uncertainty makes it difficult to look ahead. According to the latest projections used by the ECB Governing Council – which also includes new DNB President Olaf Sleijpen – to set monetary policy, inflation is stabilising around 2%. These projections assume US import tariffs of 10% and a policy rate that falls slightly further to 1.75%. Meanwhile, US President Trump is threatening to raise tariffs to 30% while negotiations are still ongoing. This makes the uncertainty surrounding the projections unusually elevated.

What about the financial conditions?

At 2%, the policy rate is around 'neutral' level. This is the level of interest rates at which the economy is neither stimulated nor cooled. The ECB also looks more broadly at financial conditions to determine whether monetary policy is easing or tightening. These include financial market rates, equity prices, and the exchange rate of the euro against other currencies.

These financial conditions remain broadly stable, particularly in light of the elevated uncertainty. Equity prices have fully recovered from their sharp decline earlier this year, and have been relatively steady recently. Interest rate spreads (e.g. the interest rate differential between different European countries) also indicate steady financial markets. However, average government bond yields did rise slightly. This may reflect higher expected government spending on defence, and, in Germany in particular, increased budget deficits and government borrowing. When governments increase borrowing, the supply of bonds increases, which can lead to higher interest rates.

In addition, the euro has appreciated, particularly against the dollar. A stronger euro tends to make European exports more expensive, which could dampen economic activity. The recent rise in the euro exchange rate partly reflects the reduced role of the US dollar as a safe haven in times of uncertainty, and may represent a possible initial reaction to the announced US import tariffs.

What is the impact of monetary policy on households and businesses?

The final stage of monetary policy transmission is the pass-through of interest rates to households and firms, e.g. through savings rates and lending conditions. These developments have been favourable. Mortgage and corporate lending rates have fallen since the ECB's rate cuts, reducing borrowing costs for households and firms.

Firms benefit from those lower financing costs. Under normal circumstances, this would support investment activity. However, in the current uncertain environment, firms remain somewhat cautious. According to the ECB's latest Bank Lending Survey (BLS) – a survey of banks on their lending conditions – corporate loan demand has increased only slightly, supported by lower interest rates but dampened by global uncertainty and geopolitical tensions.

For households, demand for mortgage loans continues to rise, mainly driven by falling interest rates. The BLS also indicates that consumer confidence and optimism about the housing market play a role: households are more positive about their financial situation and the economy, which increases their willingness to make larger purchases or take out a mortgage loan.

So why not another interest rate cut?

Economic and financial developments suggest that interest rates are currently at a broadly neutral level: not strongly accommodative, but not clearly restrictive either. At the same time, risks around the inflation outlook are two-sided, and uncertainty around US import tariffs persist. The ECB decided to keep interest rates unchanged in July to better assess the impact of previous rate cuts and get a better understanding of how the economy is developing.