Comments by Michael Krautzberger, Global CIO Fixed Income at AllianzGI, ahead of the ECB meeting on 17 April.
ECB set to cut rates by 25bp at the April meeting; trade war fears driving near-term expectations of the speed and scope of future rate cuts
- We expect the European Central Bank to cut rates by 25 basis points at its 17th April meeting, in line with market expectations, taking the deposit rate to 2.25% and continuing a run of rate cuts that began last summer.
- Fears about a global trade war have upended hopes that the Euro area was on the cusp of a durable economic recovery in 2025. The optimism from the recently announced German fiscal stimulus has quickly evaporated and been replaced by fears of a looming negative demand shock for the region.
- Short-term interest rate markets have been quick to price these downside growth risks; the ECB is now priced to cut rates over the next two meetings, while the pricing of the terminal rate in this cycle has also moved well below 2%.
- We expect further volatility ahead, with the market pricing of front-end rates oscillating to reflect either an escalation or de-scalation of tariff rhetoric. In the near term, we expect the ECB policy reaction function to be sensitive to the downside growth risks facing the region, supporting its bias to ease policy further in the coming months.
- Markets remain volatile, so we favour a tactical trading approach around the key structural themes in portfolios; this includes in our preference for yield curve steepeners.
It was barely a month ago that economic growth prospects in the Euro area were looking a little brighter for the rest of 2025 given the spending boost on defence and infrastructure announced by the next German coalition government.
The green shoots of an economic recovery have, for now at least, been suppressed as the region comes to terms with an impending trade shock. Downside growth risks for the region have re-surfaced following the US administration’s recent tariff announcements and the consequent tightening of financial conditions via equity price declines and a stronger Euro. With global growth risks now tilted to the downside, expectations have risen of a loosening of the monetary policy stance globally.
Euro area inflation dynamics also support a near-term ECB policy easing bias. Relative to the US, Euro inflation has been on an improving trajectory; core Euro CPI inflation slowed to 2.4% y/y in March, below the ECB’s own projections, while Euro services inflation has also slowed to 3.4% y/y – three-year lows. Looking ahead, further downside risks for the Euro inflation outlook are likely to emerge given the prospects of a disinflationary impulse from China (as it seeks to dump its goods into European markets), lower energy prices and the appreciation of the Euro.
Following the hawkish market commentary after the March ECB rate cut, there has been a big shift in expectations on future ECB policy. Although a few ECB members had been signalling a more cautious policy approach for April and beyond, recent comments have emphasised the downside risks to growth from trade policy uncertainty, clearly supporting an April rate cut. In the short term, the risks remain skewed towards a further lowering of the deposit rate, below the perceived 2% neutral rate, especially if we see an escalation in the trade war between the US and EU.
We remain convicted in yield curve steepeners in the current macro and policy environment, but given recent market volatility, we are biased to tactically trade around this structural view.
