MNI ECB Preview: Neutral Beckons But Markets Firmly Dovish

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Executive Summary

• The ECB is widely expected to cut its three key rates by 25bp this week, taking its deposit rate to 2.25%.
• What was originally seen as a close call after last month’s fifth consecutive cut is now seen as locked in, with 24bps priced, after the yet further escalation in global trade policies on the back of US tariffs.
• It would see the deposit rate reach the top of the 1.75-2.25% range of neutral rate estimates by ECB staff.
• Last month saw “not just […] an innocuous little change” in the language describing its policy stance, with monetary policy “becoming meaningfully less restrictive” rather than a more static restrictive previously. Some look for a further change although we think that might be a step too far this month, with a hybrid approach including a nod to an increasingly neutral setting a viable alternative.
• We would caution against reacting to this stance - changes or not - in isolation, with it needed to be viewed in conjunction with the balance of risks in the subsequent press conference opening statement.
• Inflation downside risks have grown in recent weeks, including a 90-day ‘pause’ in reciprocal tariffs where near-term odds of EU retaliation are lower but uncertainty still weighs on activity, a large decline in oil prices and a particularly buoyant euro as a relative safe haven play sees a large disconnect with rates.
• Markets are however approaching this meeting at some of their most dovish levels of the cycle, with easily more than two further cuts eyed beyond this week’s decision.