Macro views: The ECB delivered another 25bp cut alongside unchanged guidance, as expected. The main action came in the form of updated projections which showed a notable downward revision to headline inflation in 2025 and 2026. The shift is largely due to lower energy prices and stronger euro, something which Lagarde repeatedly stressed in an attempt to push back against the dovish implications. Changes to the core projections were smaller amid expectations for a looser fiscal stance and slightly tighter labour market.
Lagarde also indicated that the easing cycle is now close to its end. We continue to expect two more rate cuts, but at a slower pace. With the deposit rate now at the widely-assumed neutral mark of 2.00% the bar for further cuts will be higher. But we don’t think it’s just a headline inflation story – underlying price pressures seem to be easing and we are not especially optimistic around the chances of a ‘benign’ outcome for EU-US trade talks. We still see the terminal rate at 1.50%, but acknowledge that risks are now skewed towards fewer cuts ahead after today’s update.
FX views: EUR/USD climbed toward the 1.1500 level following the ECB’s policy update, driven by the hawkish repricing of the euro-zone rate curve. A 5bps rise in 2-year yields reflects reduced market expectations for further ECB easing. EUR/USD could test the April high at 1.1573 if upcoming US data, particularly NFP, disappoints and boosting Fed rate cut expectations. We remain comfortable with our outlook for EUR/USD to strengthen further up towards the 1.2000-level.

Macro view: In a good place, at the moment

The ‘good place’ (lower inflation and resilient growth) – The ECB cut the deposit rate by 25bp, as expected, to 2.00%. The ECB’s guidance on its approach was left unchanged: “data-dependent”, “meeting-by-meeting” and without pre-commitment to a particular rate path. Lagarde said that the decision was “virtually unanimous”, with just one dissenter on the Governing Council.

There was much more action in the updated projections. The ECB’s headline inflation numbers were revised markedly lower, as expected: from 2.3% to 2.0% in 2025 and from 1.9% to 1.6% in 2026, before returning to target in 2027. While the extent of the projected undershoot in 2026 is eye-catching, the revision is mostly a mechanical adjustment related to lower energy pricing and a stronger EUR. This was repeatedly stressed by Lagarde who seemed determined to offset the dovish implications from these new numbers.

Indeed, the changes to the core and growth numbers were smaller, as we noted was likely to be the case in our preview (here). The core figure was actually raised slightly higher in 2025 (to 2.4%) after stronger-than-expected numbers at the start of the year, before falling to 1.9% across the rest of the horizon. The projections also showed a looser fiscal stance in 2025-26, as well as firmer wage growth and a lower unemployment rate in 2027.

After the relatively firm start to the year, the ECB’s growth numbers are now exactly in line with our current figures at 0.9% in 2025 (unrevised) and 1.1% in 2026 (slightly lower). Lagarde suggested that the downward revision to 2026 is related to carryover effects from tariffs and the unwinding of front-loading effects. The statement also noted that “rising government investment in defence and infrastructure will increasingly support growth over the medium term”. All told, the tone was relatively upbeat on the outlook with policymakers holding an apparent belief in the economy’s resilience to any future shocks.

Markedly lower headline inflation projections, but little change to core

Policy outlook – Sticking with our call for further easing: New policy signals at this point always appeared unlikely. The judgement that uncertainty is at “exceptional” level remains and this is clearly a central bank that wants to keep its options open. The ECB also published some scenario analysis which shows growth and inflation falling below the baseline projections in the event of an escalation in trade tensions. On the other hand, a “benign” outcome in trade talks would boost both growth and inflation.

So future decisions will likely be less straightforward. Today’s move brings the rate to the midpoint of the range of ‘neutral’ estimates (1.75 – 2.25%) published by the ECB earlier this year (see here). Lagarde repeatedly said that the ECB is now “well-positioned” to navigate uncertainty.

Despite the obvious efforts to downplay the significance of the new inflation projection undershoot, we still think that the easing cycle will be extended. We expect that the disinflation process will go beyond a simple energy/FX story later in the year given the range of clear signals now that wage growth is cooling. The latest services print (from 4.0% to 3.2%, with the Easter distortion now absent) was encouraging in that regard.

In terms of the ECB’s new scenarios, we wouldn’t place ourselves in the ‘benign’ camp for EU-US trade talks. The landing zone for an agreement remains small and it now seems less likely, to our minds, that the EU will be bounced into a bare-bones deal while the US government contends with domestic legal challenges.

Now that the neutral mark has been reached, the bar for further easing will seem higher. Our central scenario remains that the ECB will shift to a quarterly pace of easing, skipping July, to a terminal rate of 1.50%. That said, the flexible stance means that the door remains open to a move next month despite the fairly hawkish commentary from Lagarde today. Arguments for another back-to-back cut on an insurance basis would be bolstered if trade tensions seem especially elevated around the meeting given the long gap over the summer to the next meeting (11 September). We accept that the risks are now tilted towards less easing this year, however, after today’s update.

Markets view: Hawkish ECB rhetoric reinforces upward momentum for EUR & lifts short-term euro-zone yields

EUR/USD heading for retest of April high at 1.1573

The EUR has strengthened after today’s ECB policy meeting resulting in EUR/USD rising back up towards the 1.1500-level. Today’s ECB policy update has triggered a hawkish repricing of the euro-zone rate curve reinforcing the EUR’s upward momentum against the USD. The yield on the 2-year euro-zone government bond yield has risen by 5bps as market participants have moved to pare back expectations for further ECB easing. The hawkish repricing of the euro-zone rate market and stronger EUR have been encouraged by comments from President Lagarde stating that they have “just nearly concluded the policy cycle” implying that they are not planning much if any further easing. The ECB has already lowered the policy rate from a peak of 4.00% to 2.00% bringing it into line with the ECB’s staffs’ published estimate of the neutral policy range between 1.75% to 2.25% as outlined in February.

At the same time, the updated policy statement acknowledged that rising government investment in defence and infrastructure will increasingly support growth over the medium-term, which together with other factors should make the euro-zone economy “more resilient to global shocks”. It was reflected in the updated staff GDP forecasts which expect GDP growth to pick-up to 1.3% in 2027 from 0.9% this year. The new German government’s plans for tax breaks for companies totalling up to EUR46 billion could provide additional support as well if passed in parliament. Together with the comments from President Lagarde, the ECB appears to have set a higher bar for further easing even as the ECB staffs’ forecasts for headline inflation were lowered by 0.3ppts for this year and next. The ECB appears more comfortable to leave rates on hold at their next policy meeting in July allowing it time to better assess how trade talks play out between the EU and US, and the economic impact from trade disruption. We still expect the ECB to deliver two more 25bps rate cuts by year end but acknowledge that risks are skewed in favour of less after today’s ECB update. The ECB did acknowledge though that “a further escalation of trade tensions over the coming months would result in growth and inflation being below the baseline projections” which could open the door to further easing.

The next key resistance level for EUR/USD after the 1.1500-level is the high from back in April at 1.1573. A retest could happen quickly if tomorrow’s NFP report proves to be much weaker than expected and encourages Fed rate cut expectations at either the June or July FOMC meetings. We remain comfortable with our outlook (click here) for EUR/USD to strengthen further up towards the 1.2000-level.