Traders were increasingly convinced on Thursday that the European Central Bank (ECB) would implement three more rate cuts this year. The ECB had just trimmed rates by 25 basis points to 2.75% in response to weak growth data, leaving the door open for further easing. In reaction, two-year German bond yields dipped to three-week lows at around 2.18%.
The economic news was grim as the euro zone unexpectedly contracted last quarter, missing the 0.1% growth forecast due to two years of decline in Germany. Adding to the concerns were U.S. President Donald Trump's tariff threats, though no blanket tariffs had been imposed yet.
Traders now anticipated additional rate cuts, projecting a total of 70 basis points by year-end, marking an 80% probability of three cuts, up from last week’s 60% estimate.
Barclays’ Rohan Khanna noted that the ECB's outlook appeared less optimistic, citing the recent growth data that fell short of the ECB's projections.
Following the ECB's decision, euro zone bond yields declined. Germany's two-year yield, reflecting rate expectations, saw its most significant daily drop since late November, down about 8 basis points at the close. In late trade, 10-year Bund yields decreased by 6 basis points to 2.52%, while Italian 10-year yields hit a week low at 3.58%.
Despite expectations of rate cuts negatively impacting the euro, the currency gained 0.1% against a weakening dollar as U.S. data fell short of expectations.
Europe's STOXX 600 stock index climbed 0.8%, largely unfazed by the growth data or ECB news. The euro zone bank stock index hovered near its peak from 2011.
Analysts predicted that the ECB might reduce rates below the expected 2% year-end level, aligning with estimates of the neutral euro zone rate supporting growth without constraints.
Looking ahead, Fidelity International's Salman Ahmed emphasized the potential influence of global trade tensions on ECB policy. He foresees a rate cut to 1.5% by year-end, but uncertainties post that remain to be seen.
An additional ECB rate cut in March was expected smoothly before potential debates on more easing could intensify, potentially indicating a pause in April, as some policymakers suggested.
The ECB’s move accentuated the divergence in monetary policy between the euro zone and the U.S., where the Federal Reserve refrained from immediate rate cuts on Wednesday.
The pivotal spread between U.S. and German 10-year Treasury yields, reflecting the economic gap, soared back above 200 basis points this week after briefly dipping below in November and stayed elevated amidst rising German bonds and falling U.S. yields in January.