Interest rates held steady and the ECB’s five indicators
Five indicators explain why, at least for now, the ECB has kept interest rates on hold. Four of these indicators are economic; the fifth is one that President Lagarde never mentions, even though it may be at least as important as the others: it is the psychological desire not to repeat the monetary policy mistake made during the last round of monetary tightening. It is now to be hoped that the effectiveness of this decision on the trend in market expectations will not be undermined – from the coming days right up to the next meeting – by the unfiltered comments of hawks and doves, which create unjustified fluctuations in interest rates.
The starting point is to ask under what conditions interest rates remain unchanged. There are two main cases. The first situation is where the nominal reference interest rate is the equilibrium rate, that is, it tends to correspond to the sum of the real rate – known as the natural rate – and the optimal rate of inflation. When the nominal rate is at equilibrium, it is called the neutral rate, because it reflects a monetary policy stance that is neither expansionary nor restrictive. For the euro area, although the ECB has never explicitly stated this, the neutral rate – relating to the reference rate on commercial banks’ deposits with the ECB in Frankfurt – can be considered to be 200 basis points. This level was reached in July 2025 and remained unchanged until the ECB’s meeting last June, when, by raising the rate by twenty-five basis points, the ECB shifted monetary policy from neutral to restrictive.
So yesterday, a restrictive stance on monetary policy was confirmed. We are therefore in a second scenario: the central bank has maintained a non-neutral stance, but has not tightened it further. The reason is that a central banker changes interest rates when an analysis of the expected costs and benefits convinces them to do so; and they do so by looking at five different indicators.
Starting with the objective factors, in the case of a tight monetary policy, one considers the expected benefits in terms of its effectiveness in reducing inflation, and the expected costs in relation to the corresponding risks of recession.
As the ECB’s mandate requires it to place greater emphasis on inflationary risks, central bankers must keep a close eye on the impact on prices of the geopolitical shock caused by the conflict between the United States and Israel, on the one hand, and Iran, on the other.
