ECB Surveys of Monetary Analysts

The ECB is expected to deliver a rate cut, with both Euribor and €STR futures aligning with analysts’ forecasts. The key Deposit Facility Rate is anticipated to be lowered by 25 basis points, bringing it down to 2%.

ECB lowering more than other major CBs

In comparison to its peers, the ECB continues to lower more frequently and remains 200 basis points below the Fed and BoE. The futures market implied rates see the ECB on track to have the most dovish policy in the major Western economies.
Increases in money supply, economic growth, and lowering unemployment appear to be a top priority for the ECB.

Cumulative rate cuts nearing 2023 levels

This chart shows the total amount of interest cuts priced in by the three major Western central banks over the coming two years. Overall, only about 200 basis points of total cuts are priced in now with the smallest fraction for ECB.
This reflects the ECB early abandonment of hawkish policy moves and more frequent rate cuts in the past months. At the moment, only 1 full 25 basis point cut is fully priced in for the ECB with more cuts expected by the Fed and Bank of England.

Futures implied number of cuts

The futures market is quite confident in pricing in a full 25-basis-point cut at the upcoming ECB meeting. However, expectations for a second cut are pushed out to September or October.

Core Inflation on target for the Euro Area

The key factor in the ECB’s policy committee meeting will be the inflationary pressure across the entire bloc. Core Inflation has remained around the 2% target rate for the past year being consistently lower than headline CPI. Energy deflation continues at a smaller rate as natural gas prices have been trending downward since early spring.

Inflation Dispersion among Euro Area Countries

While Euro Area inflation remains just above 2%, the difference among member states is stark. The bloc’s second largest economy, France, posted inflation at just 0.9% in April whereas the Netherlands stand at 4.1%. This underscores the difficulty of policy making across a set of diverse economies with divergent inflationary trends.

ECB rates around Taylor Rule equilibrium for Europe’s largest economy

The Taylor Rule is a formula tying a central bank's policy rate to inflation and economic growth. It assumes an equilibrium policy rate 2% above or equal to the annual inflation rate. Under this framework the current level of the policy rate is on track for an equilibrium assuming a policy rate equal to the annual inflation rate.

Euro strengthens against the US Dollar again

The Euro at is at its strongest level against the US Dollar in years despite losing some of its initial gains following Liberation Day in the US and the start of trade negotiations between the EU and the US. The decline of the Euro after the outbreak of the Covid pandemic coupled with rising interest rate differentials between the Fed and ECB. However, now the Euro remains strong during the ECB’s cutting cycle so far while interest rates in the US remain over 200 basis points higher than in Europe.

EUR/USD fair value models on upward trend – yield spread

EUR/USD fair value estimates, based on purchasing power parity (PPP), show the euro trending upward for the first time in a long time (first pane). On the bottom pane, we further expand on the spread between the EUR/USD and the regressed fair value (dark purple line) from above to illustrate the EUR overvaluation. The light purple area represents what a 10-year annualized return(EUR/USD) would have been e.g. if you had invested in EUR/USD 10 years before the 28th May 25, you would have had a 0.349% return.

Euro fair value models on upward trend – PPP (CPI)

EUR/USD fair value estimates, based on 10-year Bund/UST also indicate and upward trend. While there are no major dislocations beyond two standard deviations, the euro remains slightly overvalued while continuing to rise. The green line illustrates a fair value scenario assuming a +/- 50basis point shift in spread (currently just below 2%) by the end of May, suggesting a EUR/USD value between 0.93 and 0.957.

EuroSTOXX 50 and ECB cuts

The Eurozone headline index median performance after cuts (expressed as the black dotted line) has been muted over the past 25 years. However, it has performed exceptionally well this year in the lead-up to the June policy committee meeting – 5.48% return since the April 23rd rate cute (red line), for example. Despite the above gains, given the stock market volatility this year following the tariff announcements in the US, the European stock market will be of additional interest to investors.