Given her view that inflation risks in the euro area are higher than expected, economist Beth Beckett suspects it will not be long before the European Central Bank adopts a hawkish bias and she has pencilled in a rate hike in late 2026.
This would still leave the policy rate broadly within the eurozone’s neutral range, meaning it is neither a big drag nor a support to activity.
But tighter monetary policy is a non-consensus call (the market is pricing no change) and sounds unusual considering Capital Group’s Capital Strategy Research team expects the Federal Reserve to be cutting rates in 2026.
According to Beckett, the ECB’s latest forecasts paint a very sanguine view of inflation, with the annual headline and core rates falling smoothly over the next two years to 1.8% and 1.9% year on year in 2027, respectively. The Bloomberg consensus is even more flattering for the ECB: both the headline and core rates are expected to neatly converge on its 2% target by 2027.
To her, these forecasts look too optimistic, with the ECB and most forecasters underestimating the persistence in underlying inflation and the risk that price pressures start to build again.
Beckett’s structural view of inflation is based on her assessment that domestic demand is strengthening in an environment of constrained supply.
Two factors are limiting supply. The first is slower growth in the supply of labour given ageing and stricter immigration policies. This has meant the labour market has remained tight (the eurozone unemployment rate has hovered near its record low since early 2024) despite economic headwinds. The second is geopolitical shocks that disrupt trade and raise input prices, such as the persistent increase in EU energy prices following Russia’s invasion of Ukraine.
Together, these reduce the capacity of the economy to absorb faster growth without generating inflation.
At the same time, demand is actively being supported by looser fiscal policy. EU governments are trying to address decades of underinvestment in domestic infrastructure and defence through higher spending and bigger deficits. This began in southern Europe with the Recovery Fund and is now moving north with Germany’s substantial fiscal stimulus.
And this shift is not just confined to the EU: expectations that governments around the world would get a grip on spending in 2026 have proven too optimistic. Compared to its forecasts a year ago, the IMF now expects most advanced economies to be running larger deficits in 2026 (as reflected in the chart below).
