Could the Euro’s Recent Strength Threaten the ECB’s “Good Place”?

A Quiet Meeting in a Noisy World

Of all the major central bank meetings at the start of 2026, the European Central Bank’s was meant to be the quiet one. While the Federal Reserve and the Bank of England remain stuck in a familiar “will they, won’t they” debate, caught between stubborn inflation and increasingly fragile labour markets, the ECB has spent recent months projecting calm confidence. The euro area, policymakers have repeatedly insisted, is “in a good place”.

Why the ECB Thinks it’s in a “Good Place”

On the face of it, that confidence looks well earned. Inflation in the bloc has slipped below target, reaching 1.7% year-on-year in January. Growth (while hardly booming) surprised to the upside at the end of 2025, with GDP expanding by 0.3% quarter-on-quarter. Even Germany, which has been the euro area’s weak link in recent years, is expected to rebound in 2026 as the fiscal taps are finally opened to address years of under-investment in defence and infrastructure.

Against that backdrop, the ECB’s decision on 5 February to leave its benchmark interest rate unchanged at 2%, for the fifth meeting in a row, came as no surprise. The vote was unanimous, the statement steady, and the message consistent: policy is well calibrated, risks are broadly balanced, and there is no urgency to move in either direction.

A Strong Euro is Not a Vote of Confidence in Europe

Yet beneath the surface calm, one issue is starting to attract more attention across the continent: the euro itself.

In late January, the single currency briefly pushed above $1.20 against the US dollar, its strongest level since mid-2021. That move was eye-catching not just for its psychological significance, but for its cause. Rather than reflecting a sudden surge in euro-area optimism, the rally has largely been driven by renewed unease about the US—fuelled by protectionist rhetoric, geopolitical brinkmanship, and policy uncertainty emanating from Washington. In short, this looks less like a “buy Europe” story, and more like a “sell America” one.

Why a Stronger Euro Makes the ECB Nervous

For the ECB, a stronger euro is a mixed blessing at best. Unlike some central banks, it does not explicitly target the exchange rate. But the currency still matters—a lot—because of how it feeds into inflation and growth, the two variables that sit at the heart of monetary policy.

Start with inflation. A firmer euro lowers the cost of imported goods and energy, dampening price pressures across the economy. At a time when inflation is already below target and forecast to remain subdued, that disinflationary impulse risks pulling price growth consistently under the ECB’s 2% objective. This concern is amplified by the global backdrop: uncertain US tariff policy and the diversion of cheap Chinese exports into Europe both threaten to add to downward pressure on prices.

Growth is the other side of the coin. Many euro-area economies still rely heavily on exports to offset weak domestic demand. A stronger currency makes European goods less competitive abroad, potentially squeezing margins and weighing on activity just as the recovery is finding its footing. With the two effects taken together, and sustained over time, they could start to shift the balance of risks in a way that matters for policy.

It is here that the euro’s recent strength becomes more than a market curiosity. In an extreme scenario, prolonged currency appreciation could force the ECB to reconsider its comfortable stance, reopening the door to rate cuts not because of a deterioration in fundamentals, but because external forces are quietly doing the tightening for it.

Lagarde Keeps Her Cool

For now, however, ECB President Christine Lagarde is not losing any sleep. At the post-meeting press conference, she deftly swatted away attempts by journalists to draw a direct line between the stronger euro and future policy moves. The euro area, she maintained, remains resilient and in a “good place”. The Governing Council would also be guided by broad trends in the data, not by individual data points, when it comes to making decisions.

Lagarde did acknowledge that the ECB “monitors the exchange rate”, but was careful to stress two important caveats. First, the Bank does not target the currency, only inflation. Second, the euro’s current level is still well within historical norms and broadly consistent with the ECB’s baseline projections. In other words: nothing to see here, yet.

Markets Are Less Relaxed

Markets, unsurprisingly, are less sanguine. Investors are already pricing in roughly a one-in-five chance of further rate cuts later this year, reflecting the view that the ECB’s margin for comfort may be thinner than policymakers suggest. And with 2026 already proving to be anything but dull, it would be rash to rule out further dollar weakness, or renewed upside pressure on the euro.

The bigger point is this: the ECB’s “good place” rests on a delicate balance. Inflation is low but not too low. Growth is modest but improving. Policy is restrictive enough, but not restrictive enough to choke off the recovery. A materially stronger euro threatens to upset that equilibrium, even if it does not yet demand an immediate response.

When Comfort Becomes Complacency

For now, the ECB can afford to stay patient. But if the euro continues to do the tightening on its behalf, patience may eventually give way to pragmatism. In foreign exchange, as in monetary policy, stability is less a destination than a temporary stop along the way.