How much longer can the eurozone hold out? The ECB has reached the end of its rate hike cycle

   In June 2024, the European Central Bank (ECB) announced a 25-basis-point rate cut as expected, marking the start of its first easing cycle since 2019 and signaling the official end of nearly two years of aggressive rate hikes.

While this shift was largely anticipated by the market, it also exposed a deeper issue: the eurozone's economic fundamentals can no longer sustain the policy lag effects of high interest rates. This abrupt policy pivot from tightening to easing may merely be the beginning of larger shocks to come.

Against the backdrop of persistent high inflation, near-stagnant growth, divided fiscal policies, and mounting debt pressures, has the ECB lost the flexibility to address complex economic conditions? Does the eurozone's “community structure” still possess sufficient resilience? How much longer can the eurozone endure?

The ECB's “end of rate hikes”: From passive inflation control to inability to sustain

1. From inflation peak to rate cut starting point

In 2022, the Russia-Ukraine war triggered a surge in energy prices, pushing European inflation above 10%, forcing the ECB into a rate-hiking cycle. Since July 2022, the ECB has raised rates 10 times in a row, lifting the main refinancing rate to 4.5%, the highest level since the euro's inception.

However, by mid-2024, eurozone inflation had rapidly declined:

Core CPI has fallen below 2.9%;

The base effect of energy prices has faded;

Consumer spending remains weak, and service sector price hikes are lackluster;

Industrial producer price index (PPI) remains negative.

While the “fever” of inflation has temporarily subsided, the ECB is well aware that this is due to suppressed demand and near-stagnant economic growth, rather than a genuine resolution of inflation.

2. The ECB's policy “limits” have become evident

Unlike the Federal Reserve, which is supported by a strong labor market and the dollar's hegemony, the ECB is constrained by structural differences among member states, debt burdens, and financial market fragmentation. While rate hikes are beneficial for controlling inflation, they have severely impacted high-debt countries in Southern Europe and hindered industrial investment in core economies like Germany and France.

More critically, the eurozone's structural weaknesses have significantly weakened the effectiveness of monetary policy:

The banking system has weak credit transmission capabilities;

Debt interest expenses are growing rapidly, compressing fiscal space;

Market tolerance for continued tightening is declining.

Thus, even as inflation has not yet returned to the 2% target, the ECB was forced to “preemptively pivot,” declaring the “end of the rate-hiking cycle” and attempting to repair the fragile economy through small rate cuts.

The real pressure on the eurozone: not just “stagflation,” but “structural recession”

Although inflation has temporarily eased, the crisis currently facing the eurozone is far more complex than mere growth stagnation.

1. Economic growth has nearly ground to a halt

In the first quarter of 2024, eurozone GDP grew by just 0.1%. Germany has been on the brink of “technical recession” for several consecutive quarters, while France and Italy's growth rates have barely held steady. While the unemployment rate remains low, the actual quality of employment and labor participation rates have deteriorated.

Manufacturing continues to contract, with the PMI consistently below 50;

The service sector is also beginning to slow down;

Private investment is lackluster, and business confidence indices continue to decline;

Exports are being suppressed by both a strong US dollar and weak external demand.

The entire Eurozone economy is sliding toward a “Japanese-style dilemma” of low growth, low inflation, and high debt.

2. Debt pressures are mounting, and fiscal risks are spreading

Many countries have expanded their fiscal policies on a large scale after the pandemic, leading to a rapid rise in debt ratios:

Italy's government debt-to-GDP ratio has exceeded 140%, and it is called “the biggest uncertainty in the eurozone”;

France's fiscal deficit is as high as 5.5% of GDP, triggering market concerns;

Germany is forced to restrict spending due to the “debt brake” mechanism, exacerbating the fiscal stalemate.

Although the Eurozone shares a common currency, it lacks a unified fiscal adjustment mechanism. This means that once market confidence wavers, the risk of a sovereign debt crisis in Southern European countries could resurface.

3. Population aging and labor shortages

Birth rates in most European countries continue to decline, leading to severe mismatches between labor supply and demand, with structural unemployment remaining intractable. Young laborers are concentrating in Northern Europe and Germany, exacerbating the “hollowing out” of the working-age population in Southern Europe.

This not only drags down potential economic growth rates but also exacerbates pension and social security burdens, constraining fiscal expenditure structures.

The Euro's Vulnerable Pillars: Capital Outflows and Currency Confidence

1. The Euro's Persistent Weakness Against the US Dollar

As the ECB shifts toward easing, monetary policies between Europe and the US are diverging further. The US dollar continues to attract global capital supported by high interest rates, while the euro faces pressure due to weak growth and policy shifts.

In June 2024, the euro fell below 1.07 against the US dollar again, with the market expecting further weakness within the year.

While euro depreciation may boost export competitiveness, the bigger issue is the loss of confidence and capital flight:

Foreign investors are reducing holdings of European bonds and stocks;

Family offices and multinational capital are increasing dollar asset allocations;

The euro's share in international reserve currencies is declining.

2. Lagging capital market performance

Compared to the strong rebound in US stocks, European stocks have been constrained by a high weighting of cyclical industries, a lack of technology companies, and limited policy tools, resulting in lackluster overall performance. Especially in traditional sectors such as energy, banking, and real estate, corporate profit recovery has been slow.

This gap in asset returns further drives capital outflows, which in turn exacerbates valuation pressures on euro assets.

Policy Dilemma: Limited room for easing, fiscal coordination difficult to implement

1. Interest rate cuts unable to prop up the economy alone

Although the ECB has initiated interest rate cuts, the transmission mechanism is not functioning smoothly: the banking system's risk appetite has decreased, and it is unwilling to expand credit issuance; corporate investment sentiment is low, making it difficult to achieve effective credit expansion.

This “monetary trap” scenario means that central bank easing alone cannot reverse the broader trend, and may even trigger asset bubbles and financial risks.

2. Fiscal coordination mechanisms are largely ineffective

While the Stability and Growth Pact imposes strict requirements on deficits and debt, most countries have long since failed to comply. Policy objectives between Germany, France, and Italy are severely divergent, and the European Commission's repeated efforts to promote “fiscal integration” have yielded limited results.

The Eurozone lacks a mechanism akin to the Federal Reserve and Treasury Department's “strong joint action,” leaving countries to act independently whenever crises loom. This institutional division keeps the Eurozone in a state of “fragile equilibrium.”

How much longer can the Eurozone endure? Three future scenarios

Scenario One: Soft Landing and Structural Transformation (30% likelihood)

If the ECB precisely controls the pace, inflation continues to decline, and the economy gradually stabilizes, the eurozone may find growth momentum in the next round of green transformation, AI industry investment, and supply chain repatriation. However, this requires:

Strong fiscal stimulus + effective monetary easing;

The EU to advance fiscal coordination and debt-sharing mechanisms;

Geopolitical stability and controllable energy prices.

In reality, this ideal scenario faces significant obstacles.

Path Two: Persistent Stagflation Trap, Entering a Low-Growth Era (50% Likelihood)

The most likely reality is that the Eurozone falls into a Japan-like “chronic recession”:

Inflation remains between 1% and 2%, with low nominal interest rates;

Annual economic growth averages less than 1%, with insufficient investment vitality;

Structural reforms lag, and debt accumulates slowly;

Young people are disillusioned, and the burden of an aging population rises.

This is a “safe but unsolvable” pattern that erodes confidence over time.

Path Three: Sudden Debt or Market Crisis Triggers Systemic Adjustment (20% likelihood)

If Italy or France faces a debt trust crisis, or regional banks experience systemic defaults, the ECB may be forced to restart quantitative easing (QE) and large-scale interventions, potentially triggering a stress test on the monetary system. At that point, the euro's creditworthiness would once again be challenged.

While this crisis is not inevitable, its likelihood is increasing over time.

The ECB's rate cut marks a fundamental shift in European policy logic: from “anti-inflation” to “growth preservation.” However, the issue is that there are few tools remaining, and options are no longer abundant.

How much longer can the eurozone hold on? It depends on whether it can forge a collective will within its complex structure, restore confidence within limited policy space, and redefine a growth path amid external pressures and internal contradictions.

While financial markets remain fixated on the Federal Reserve's next move, perhaps we should shift our focus to Europe—this “old pillar” of the global economy—and ask whether it still has the potential to rebound once more?