While the US Federal Reserve lowered its key policy rate, the European Central Bank remains on hold. The jury is out on the trajectory for policy rates in 2026.
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As expected, policymakers at the Fed lowered the federal funds rate at their meeting on 9 December for the third time this year, taking the target range from 3.75-4.00% to a three-year low at 3.50-3.75%.
The decision was not unanimous. Not surprisingly, ultra-dovish Fed Governor Stephen Miran dissented and voted for a 50bp cut. Somewhat less expected, Chicago Fed President Austan Goolsbee joined Kansas City Fed President Jeffrey Schmid and voted for no change.
With three votes against the majority decision, the Fed had had as many dissenters since July as it had over the preceding 47 meetings.
While the range of views at the Fed may be historically unusual, it reflects an environment where visibility for policymakers is poor due to uncertainty over the impact on the economy of the US’s import tariffs and the absence of reliable data after the recent US federal government shutdown.
Treating the employment data with caution
On 16 December, a combined non-farm payroll report for October and November showed the US unemployment rate rose to 4.6% in November, the highest level since September 2021, suggesting some weakness in the labour market.
The economy added 64,000 jobs in November, but shed 105,000 in October. At first glance, this data would appear to bolster the case for the Federal Reserve to cut interest rates further in the new year. But Fed Chair Jerome Powell last week warned that because technical issues could distort the data, he and his colleagues would be treating the report with caution.
Not so bad after all
Close examination of the latest employment data suggests the rise in the unemployment rate does not give grounds for much concern.
The main factor was an unexpected increase in the number of people re-entering unemployment. The number of those entering unemployment for the first time, and those who lost jobs and began seeking work, remained largely unchanged.
Excluding these ‘re-entrants’, the unemployment rate would have stayed at 4.4% in November. In addition, the rise also was entirely seen in the cohort aged 16-19, whose jobless rate climbed from 13.2% in September to 16.3% in November, while the rate for those aged 20 and over remained constant at 4.1%.
One possible explanation is the unusually low 64% response rate in the Bureau of Labor Statistics’ household survey. This may be the reason behind the sharp rise in unemployment for 16-19 year-olds and the acceleration in labour force participation rate, which rose from 62.2% in July to 62.5% in November.
December’s non-farm payroll report, scheduled for publication on 9 January 2026, may well show adjustments for the one-off increase in the jobless rate and leave the Fed with little reason to cut rates at its meeting on 17-18 January.
A ratcheting-down of US employment growth
The rise in employment by 64,000 month-over-month in November, following a 105,000 decline in October, brings the three-month average of monthly gains to 22,000 – down from 51,000 in September and well below the 126,000 recorded in April.
It is probable that the negative data for October reflects a 162,000 drop in federal employment, with the US administration’s deferred resignation programme resulting in employees leaving the payrolls.
Healthcare jobs continue to drive employment gains, rising by 64,000 in November after 65,000 in October – and up 770,000 since last year (more than 80% of year-on-year total job gains).
A shrinking labour pool?
There was positive news on wage inflation in this report. Average hourly earnings rose by 3.5% year-over-year in November, down from 3.7% in September. However, changes in the level of wages are gradual and backward looking.
The big known unknown is how labour shortages from immigration restrictions will eventually impact wage growth.
In theory, a smaller labour pool should add to upward pressure on wages, particularly if labour demand increases in 2026 due to the fiscal stimulus from the One Big Beautiful Bill.
US consumers carry on shopping
Although the US economy may be creating fewer jobs, the consumer remains undeterred. Retail sales for October were unchanged at the headline rate, but the data (retail sales excluding cars, building supplies and petrol stations) that feeds directly into GDP rose by 0.8% month-over-month – the highest since June – despite the government shutdown.
The consumer appears to have kept calm and carried on spending in October. Whether this momentum can be maintained through November and December is questionable, but overall household consumption in the fourth quarter is likely to rise and make a significant positive contribution to the GDP data.
Fed’s outlook is positive
Overall, the message from Fed policymakers on the prospects for the US economy was positive after their meeting on 9-10 December.
The December Summary of Economic Projections (SEP) shows the Fed now expects real GDP to grow by 2.3% YoY in 2026, well above the 1.8% estimate three months ago. Fed Chair Jerome Powell said in the press conference that the upward revision reflected resilient consumer spending and strong business investment supported by artificial intelligence-related spending.
ECB on hold
The governing council of the European Central Bank meets on 18 December, but no change is expected in monetary policy with the deposit rate seen remaining at 2.0%.
ECB board member Isabel Schnabel has said recently that she agrees with those in the market expecting the next move to be an interest rate rise, but she gave no indication of the timing.
Since June 2025, the ECB has emphasised that it is in a ‘good place’. From an economic perspective, not much has changed since the last meeting on 30 October:
- Growth in the Eurozone in the third quarter was revised up slightly from 0.2% to 0.3% QoQ, exceeding the ECB’s forecast
- The Eurozone Composite PMI Output index declined to 51.9 in December from 52.8 in November, a 30-month high
- However, exports have remained sluggish due to higher tariffs, a strong euro, increased global competition and the political situation in France
- The ECB expects these headwinds to fade in 2026, while a stable labour market, a growing services sector, and German fiscal stimulus provide a tailwind to the eurozone economy
- The inflation rate is hovering at around 2 %.
In our view, lower energy prices, weaker wages, a stronger euro, diversion of Chinese goods from the US to Europe due to the US import tariffs will put downward pressure on inflation and lead the ECB to cut rates in 2026.
Last week’s news that China’s trade surplus with the rest of the world for the first time exceeded $1tn adds to market concerns about disinflationary forces from China. The trade surplus with the EU has almost doubled to $300bn in 10 years.
In Beijing, IMF managing director Kristalina Georgieva last week warned of China’s trade relation ‘imbalances’, while French President Emmanuel Macron said they were ‘unsustainable’.
The single largest increase to the trade surplus this year came from cars. China’s surplus for the sector was up by $22bn in the first 10 months of 2025 compared with the same period last year, taking the total to $66bn. Europe’s car manufacturers, major employers across the continent, are struggling to compete with Chinese imports.
