European Central Bank December Meeting Minutes: Monetary Policy "in a Good State," Will Continue to Remain Highly Flexible in the Future

The European Central Bank's Governing Council decided to keep interest rates unchanged at the meeting on December 17-18. The minutes released on Thursday show that the decision-makers believe the current monetary policy stance is "in a good position," able to maintain a balance between supporting the economy and curbing inflation, while emphasizing that the policy is not set in stone.

The minutes point out that the European Central Bank will continue to maintain a high degree of flexibility, reserving ample options for upward or downward adjustments to interest rates, in order to respond promptly to changes in economic and inflation prospects.

The European Central Bank stated that despite facing global trade challenges, macroeconomic data in the eurozone mostly exceeded expectations in 2025, and the impact of U.S. tariffs has proven to be milder than initially expected. In December, the central bank revised its GDP growth forecasts for 2025 and 2026 upward by 0.2 percentage points each.

Regarding inflation, the European Central Bank reiterated that inflation should stabilize at the 2% target in the medium term, but the stickiness of service sector inflation and wage growth has exceeded expectations. The overall inflation rate remained at 2.1% in November, while service sector inflation rose to 3.5%. Employee compensation growth in the third quarter unexpectedly increased for the third consecutive time, with a year-on-year growth rate of 4%, mainly driven by additional payments outside of contractual wages.

Market Interest Rate Expectations Shift

The market's repricing of the European Central Bank's policy path is prominently reflected in the minutes. The minutes state that since the October meeting, "the market narrative that the European Central Bank's interest rates are in a good position has been further solidified." The overnight index swap curve shows that investors believe the policy rate will remain at current levels for an extended period, with the next move likely being an interest rate hike rather than a cut.

The implied uncertainty surrounding the expected path of the European Central Bank's policy rate has significantly decreased. The nominal overnight index swap rate for the eurozone's ten-year term has risen by 26 basis points since the October meeting, primarily driven by rising real rates. Decomposition shows that domestic factors—namely, the positive macroeconomic developments in the eurozone and expectations of the European Central Bank tightening monetary policy—are the main drivers of the rise in long-term rates.

Members of the Governing Council unanimously supported keeping the three key interest rates unchanged. The minutes indicate that since the last rate cut in June of last year, financial conditions have remained in a narrow range, closely aligned with the key policy rates. The newly introduced macro-financial conditions index by the European Central Bank shows that financial conditions have closely tracked the central bank's key short-term rates during the latest policy cycle.

Economic Resilience Exceeds Expectations

The performance of the eurozone economy became the core highlight of the meeting discussions. Economic growth of 0.3% in the third quarter was mainly attributed to increased consumption and investment. Despite drastic changes in global trade policies and heightened geopolitical uncertainty, the eurozone economy has shown unexpected resilience.

According to Bloomberg's Citigroup Economic Surprise Index, most macroeconomic data in the eurozone for 2025 has surprised on the upside, with the range of surprises being the smallest in the past twenty years, despite high geopolitical uncertainty. This underscores the resilience of the eurozone.

The December central bank forecast indicates that the eurozone's GDP growth rate for 2025 is projected at 1.4%, which is 0.5 percentage points higher than the March forecast before the U.S. announced tariff increases in April. In the coming years, the economy is expected to grow steadily at a pace close to or slightly above potential levels Domestic demand is expected to be the main engine of growth, with real income further rising and the savings rate gradually declining from a high level to support consumption. Significant corporate investment and government spending on infrastructure and defense should increasingly support the economy in the coming years.

The labor market remains strong. The unemployment rate in October was 6.4%, close to historical lows. Employment growth in the third quarter was 0.2%, up from 0.1% in the second quarter. Meanwhile, labor demand has further cooled, with the job vacancy rate in the third quarter dropping to a pandemic-era low of 2.2%.

Inflation Stickiness Raises Concerns

Despite overall inflation stabilizing around the 2% target, the stickiness of service sector inflation and wage growth exceeding expectations became important topics of discussion at the meeting. The overall inflation rate in November remained at 2.1%, stable within a narrow range since spring. Service sector inflation rose from 3.2% in September to 3.4% in October and 3.5% in November.

Wage growth consistently exceeding expectations is particularly noteworthy. Employee compensation growth in the third quarter unexpectedly rose for the third consecutive time, with a year-on-year growth rate of 4%, especially pronounced in the eurozone's largest economy. This surprise was driven by additional payments outside of negotiated wages, which were not captured by the European Central Bank's wage tracker.

Some members believe that strong wage growth may be one reason why service sector inflation is stickier than expected. Compared to 4% in November 2023 and 3.9% a year later, service sector inflation is expected to only drop to 3.5% two years later. There is a view that the "last mile" anti-inflation process that began two years ago is still not fully over.

Central bank forecasts indicate that inflation excluding energy is expected to stabilize around 2% by 2027-28. Core inflation is projected to decline from 2.4% in 2025 to 2.2% in 2026 and 1.9% in 2027, before stabilizing at 2.0% in 2028. However, some members expressed concerns about inflation remaining below target for the next two years, fearing that this could lead to a downward de-anchoring of inflation expectations