The European Central Bank's "One Rate Hike" Path: Inflation Cycle and Monetary Policy Shift

The ECB's 'One-and-Done' Rate Hike Path: Inflation Cycle and Monetary Policy Shift

While major central banks around the world have generally taken aggressive rate hikes to curb inflation, the European Central Bank (ECB) may take a very different path: ending the current tightening cycle after just one rate increase. This "one-and-done" scenario reflects the special nature of the euro area’s economic cycle and a deep shift in monetary policy.

Rapid Turn in Inflation: From Peak to Return

The core variable facing the ECB is the trajectory of inflation. Since the energy crisis pushed inflation into double digits in 2022, the euro area Consumer Price Index (CPI) has fallen significantly. By the second quarter of 2024, headline inflation had dropped to below 2.5%, and core inflation has also gradually moderated under the lagged effects of service prices and wage growth. The accelerated transmission of monetary policy to the real economy has helped anchor inflation expectations near the 2% target.

The ECB’s latest projections indicate that inflation will stabilize around 2% in 2025, meaning current interest rates are already sufficiently restrictive. Unlike the Federal Reserve and the Bank of England, the ECB does not face a significant risk of a wage-price spiral; although the euro area labor market is tight, weak productivity growth and sluggish demand have curbed second-round effects.

Stagnant Economic Growth: Calibrating Monetary Policy Restraint

Euro area economic growth stagnated in the second half of 2023, manufacturing continues to contract, and exports are weighed down by weak global demand. Germany, the region’s economic engine, even faces the risk of a technical recession. This weakness leaves the ECB with very limited room for rate hikes—any additional tightening could push the economy into recession.

The ECB’s policy stance is shifting from "fighting inflation" to "stabilizing growth." The current deposit facility rate of 3.75% is already above the estimated neutral rate (around 1.5-2.0%), meaning monetary policy is in restrictive territory. Further rate hikes would increase corporate financing costs and mortgage pressures on households, accelerating the economic downturn.

The 'One-and-Done' Global Reference: Diverging Monetary Policy Cycles

The Federal Reserve implemented 11 rate hikes in 2023, totaling 525 basis points; the Bank of England also raised rates 14 times. In comparison, the ECB has only raised rates nine times since starting in July 2022, for a cumulative 425 basis points. If the September meeting delivers just a 25-basis-point hike, the total cycle would amount to 450 basis points, far below other major central banks.

This divergence stems from differences in the euro area’s economic structure: it relies more on bank financing than capital markets, the share of household floating-rate mortgages is lower than in the US, and it is more passive in importing energy. At the same time, the euro's low-inflation tradition and the ECB's single mandate (price stability) make it more sensitive to output gaps.

Structural Challenges and Long-Term Policy DirectionEven after ending rate hikes, the ECB's balance sheet normalization will continue. The reinvestment of maturing bonds under the Pandemic Emergency Purchase Programme (PEPP) has stopped, and the repayment of Targeted Longer-Term Refinancing Operations (TLTRO) is underway. The liquidity tightening from balance sheet reduction is equivalent to additional monetary tightening.

In the long term, the euro area faces structural pressures such as an aging population, insufficient digital transformation, and geopolitical fragmentation. This requires the European Central Bank to maintain price stability while providing room for fiscal policy support—highly indebted Italy and France could become potential drivers of future rate cuts.