Debt, Discipline and Market Trust

Researchers from the Centre for Central Banking at Frankfurt School of Finance & Management, together with the University of Bonn, have prepared a study for the Committee on Economic and Monetary Affairs (ECON) of the European Parliament.
The report examines the economic situation in the euro area, the ECB’s monetary policy stance, and its communication strategy.

The study was published on 1 October 2025, ahead of the Monetary Dialogue with the ECB President on 6 October 2025. Under the title “Wait and Watch: Steering Monetary Policy Under Balanced Inflation Risks”, it concludes that inflation has settled at the ECB’s two percent target. While energy and goods prices have eased, services inflation remains persistent. As a result, price pressures are limited but continue.

Overall, risks to the inflation outlook are considered balanced: upside risks stem from fiscal impulses, trade conflicts, and energy markets, while weaker global growth, a stronger euro, and cooling labour markets could have a dampening effect.

“The disinflation process that began at the end of 2022 now seems largely complete. Inflation is close to the target, and risks are broadly balanced – this allows the ECB to steer policy with a steady hand,” explains Professor Dr Benjamin Born, Professor of Macroeconomics at the University of Bonn and co-author of the report.

After eight consecutive rate cuts, which ended in June 2025, markets now expect stable interest rates while the ECB continues to reduce its balance sheet. This results in a largely neutral monetary policy stance. Nevertheless, financial conditions remain somewhat tight: borrowing costs for companies have declined, but households and governments have yet to fully benefit from this development. Long-term yields also remain elevated, as higher term premia offset falling rate expectations.

“Our analysis shows that the fragmentation of government bond markets in the euro area, which was pronounced at the beginning of the tightening cycle, has since declined. This has improved monetary policy transmission. However, risks of renewed fragmentation remain and need to be closely monitored,” says Professor Dr Emanuel Mönch, Professor of Financial and Monetary Economics at Frankfurt School of Finance & Management and co-author of the study.

ECB communication: Scope for clearer guidelines on the reaction function

The study also devotes attention to the ECB’s communication. The shift towards a data-dependent, meeting-by-meeting approach is seen as appropriate in the current environment of heightened uncertainty. At the same time, clearer communication on the so-called reaction function – explaining how the ECB would respond under different scenarios – could improve transparency, reduce uncertainty about the inflation outlook, and better anchor expectations.