What ECB Policy Outlook Means for EUR/USD in 2026: The Rate Gap Game

The real question heading into 2026 isn’t just what the ECB will do—it’s what the policy outlook means when stacked against the Fed’s playbook. And right now, the market is split down the middle.

On one side, Citi sees the dollar winning: they project EUR/USD sliding to 1.10 by Q3 2026, betting that US growth holds while the Fed cuts less than consensus expects. On the flip side, UBS argues the opposite—if the ECB stays parked while the Fed keeps easing, the yield gap compresses and the euro edges higher toward 1.20 by mid-year. The difference between 1.10 and 1.20 isn’t noise; it’s roughly a 9% swing, and where you stand on the 2026 outlook determines which side of that trade you’re on.

The Eurozone is sluggish, but it isn’t breaking

Europe’s growth engine is sputtering. The Commission’s autumn forecast shows 1.3% growth this year, 1.2% next year, and 1.4% in 2027—notice that dip in 2026. It’s not a crash, but it’s telling: next year could be bumpier than the consensus likes to admit.

The headwinds are real. Germany’s auto sector has contracted 5% as the EV transition collides with supply-chain friction. Underinvestment in innovation means chunks of Europe are falling behind the US and China on tech. Then there’s the Trump tariff threat: the administration is eyeing 10%-20% levies on EU goods, and early estimates suggest EU exports to America could drop 3%, with autos and chemicals taking the hardest hit.

Yet here’s where the resilience show up. In Q3, the Eurozone expanded 0.2% quarter-on-quarter, but Spain (0.6%) and France (0.5%) fired while Germany and Italy flatlined. It’s not uniform, but it’s not crumbling either. That mixed-but-stable picture is exactly why the euro hasn’t looked completely broken despite the growth disappointments.

Inflation creeping back changes the ECB’s calculus

Eurostat just pegged Eurozone inflation at 2.2% year-on-year in November, up from 2.1% in October—and it’s sticky. Energy prices dropped 0.5%, but services inflation jumped to 3.5%, up from 3.4%. Services is the red flag: it’s the component central banks dread seeing re-accelerate because it signals wage and demand pressures aren’t cooling.

The ECB responded on December 18 by holding all three rates unchanged: the deposit facility at 2.00%, the main refinancing rate at 2.15%, and the marginal lending facility at 2.40%. With cuts paused since mid-2025 and new projections suggesting inflation drifts toward target over three years, the base case for 2026 is a stationary ECB—no rush to cut, no urgency to hike. President Lagarde called policy a “good place,” which in central-bank speak means “no immediate action needed.”

Economists broadly agree. Union Investment doesn’t expect a move in the near term; Citi strategists suggest any shift probably arrives in late 2026 or 2027. A Reuters survey found most economists expect the ECB to keep rates frozen through 2026 and into 2027, though 2027 forecasts range from 1.5% to 2.5%—a tell that confidence evaporates further out.

The Fed’s cutting bias looks set to continue

The Fed pivoted hard in 2025. After March’s hold (tariff concerns), it cut three times in the second half as inflation cooled and labor softened—September, October, December—bringing the federal funds range down to 3.5%–3.75%. That’s already faster than its December 2024 projection of two cuts.

Here’s where politics enters: Jerome Powell’s term ends May 2026, and he’s widely expected to step aside. Trump has been vocal about the Fed cutting too slowly and has hinted the next chair will push easing faster. Trump plans to pick his replacement in early January, with someone potentially aligned to a more aggressive rate-cut stance.

The forecasts cluster around two cuts for 2026. Goldman Sachs, Morgan Stanley, Bank of America, Wells Fargo, Nomura, and Barclays are all cited as expecting two 25-bp reductions, landing the funds rate near 3.00%-3.25%. Nomura places those moves in June and September; Goldman pencils them in for March and June. Moody’s chief economist Mark Zandi goes further, expecting multiple cuts—not because the economy is booming, but because it’s locked in a “delicate balance.”

EUR/USD comes down to two vectors

In 2026, the euro is essentially a referendum on whether European growth holds up while the Fed keeps cutting and whether the ECB stays patient.

Scenario One: Eurozone growth exceeds 1.3% and inflation edges up gradually. The ECB maintains its hold. Under this outcome, the rate gap widens in Europe’s favor and EUR/USD could push above 1.20.

Scenario Two: Growth disappoints below 1.3%, the trade shock bites, and the ECB eventually leans toward easing. That flips the narrative—the euro’s rally caps quickly and EUR/USD reverses toward 1.13, or potentially lower to 1.10.

The institutions aren’t unanimous. Citi’s base case hinges on slower-than-expected Fed cuts and sustained dollar strength, which is why they target 1.10. UBS flips the logic: ECB pause + Fed cuts = yield compression = euro gains, hence the 1.20 call. Both have merit; both depend on assumptions about growth, inflation, and policy divergence that won’t be locked in until later in the year.

The outlook for 2026 ultimately turns on a rate differential that both sides understand, but disagree on who it favors.