Weekly update - ECB and Fed: diverging signals heading into 2027
Activity and inflation data released in October point to diverging monetary policy expectations on either side of the Atlantic.
In the United States, positive surprises in growth and the acceleration of core inflation support the Fed's policy rate increase and heighten the risk of a faster tightening cycle in 2027.
In the euro area, while the ECB has effectively signalled a rate hike in December, resilient growth, core inflation stabilising at 2.5%, and expectations of lower energy prices argue for a more limited tightening cycle in 2027.
The Fed may adopt a more restrictive tone toward year-end
The U.S. economy continues to deliver upside surprises, both in terms of growth and inflation. The stronger-than-expected GDP growth recorded in Q3 2026 was followed by another set of encouraging survey data for October. The labor market also confirms this resilience, with job creation continuing to trend above 160,000 jobs per month and the unemployment rate remaining anchored at 4%.
This resilience in economic activity has been accompanied by inflation remaining above 2% since 2021, with the gap widening in recent months. Core inflation reached 2.9% in October, while its services component, closely monitored by the Fed, rose to 4.1%. As a result, beyond energy- and tariff-related shocks, inflationary pressures appear to be spreading across a broader range of goods and services.
Against this backdrop of sustained growth, a robust labor market, and rising inflation, the Fed is expected to raise its policy rate to 4.25% in December while maintaining a restrictive stance. We believe the Fed will continue its tightening cycle into 2027, with a terminal rate of 5% should current trends persist.
A macro backdrop that could favor an ECB pause in early 2027
Like the U.S. economy, euro area survey and activity data released in October continue to point to growth close to 1%, broadly in line with potential growth. PMI surveys and the European Commission's confidence indicators remain in expansionary territory, while September orders received by Germany also suggest that activity remains well supported.
At the same time, October inflation data paint a more nuanced picture. While headline inflation continued to accelerate to 4% year-on-year, this increase was largely driven by higher energy prices. Excluding energy and food, inflation stood at 2.5% year-on-year, a level that has remained broadly stable since 2024, with goods inflation still low at around 1% and services inflation steady at roughly 3%. Neither underlying prices nor wage developments therefore point to a broadening of inflationary pressures or significant second-round effects stemming from the energy shock.
Against this backdrop, the ECB has effectively signalled a further step in its tightening cycle in December, with the policy rate expected to rise to 2.75%. However, given the relatively contained underlying inflation pressures, the prospect of lower energy prices, and ongoing political uncertainties, we expect the tightening cycle to remain limited in 2027, with a terminal rate of 3%.