ECB cuts again, more expected

The ECB cut the deposit rate by 25bps to 2.75% at yesterday’s meeting, as expected, bringing the cumulative reduction since last June to 125bps. Moreover, with Euro area economic activity remaining weak, inflation expected to fall to 2% this year, and monetary policy still restrictive, the ECB signalled further reductions over the coming months. Data published before the rate decision showed Euro area GDP stagnated in the final quarter of 2024, while the US economy expanded at a solid pace over the same period according to the latest GDP data there. Also, late yesterday, Donald Trump said he is inclined to go ahead with 25% tariffs on Canada and Mexico from tomorrow. The upshot of all this is the dollar is generally firmer this morning. The euro and sterling have slipped to around $1.0390 and $1.2420 against the US currency, with EURGBP a touch weaker at £0.8360 (leaving it on track to end lower for a second week running).

With ECB rate cut expectations firming following yesterday’s meeting – the market is pricing in at least another 75bps reduction by the end of this year – Euro area bonds rallied with German 2- and 10-year yields falling by around 7bps and 5bps respectively. Equivalent UK yields saw similar declines, while US bonds underperformed with yields little changed on the day. In equity markets, European stocks staged a decent rally, finishing with gains of around 1%, while US indices added around half a percent.

The Euro area economy stagnated in Q4 2024 with GDP flat on the quarter – having increased by 0.4% in Q3 – dragged down by a contraction in activity in both the German and French economies, while Italy’s economy fared little better, registering no growth in the quarter. In contrast, the US economy expanded at a solid pace again in Q4, with GDP increasing by 0.6% – led by another strong rise in consumer spending – down only slightly from growth of 0.8% in Q3.

Looking to the day ahead, the latest PCE inflation report in the US is expected to show headline inflation nudging up to 2.6% in December from 2.4% in November, according to the consensus forecast, with core inflation is expected to remain at 2.8%. The employment cost index (ECI) for Q4 is due in the US as well, while a flash reading for January inflation is scheduled in Germany (headline inflation is expected to remain at 2.8% this month). Also, the ECB publishes its latest survey of consumers’ inflation expectations.