June ECB cheat sheet: Inflation, Davos and the ‘global euro’

A 25bp ECB rate cut at the 5 June meeting looks all but certain. Markets have nearly fully priced it in for weeks, and the consensus is unanimous. Still, there will be plenty to watch – from updated economic projections, to speculation that President Christine Lagarde might leave the ECB to head to the World Economic Forum in Davos before her term ends in 2027.

Our baseline scenario, shown in the image above, points to a moderately dovish surprise. This would come from a more benign inflation outlook in the new projections, even as concerns about growth remain elevated. The ECB has been cautious not to offer clear guidance, but it has also downplayed the importance of both the restrictive policy and neutral rate concepts.

The Governing Council may now view policy as no longer restrictive – or even neutral – but recent signals suggest that, given inflation below target and increasing downside risks to growth, the ECB prefers not to place too much emphasis on the neutral rate idea.

As of now, the market is eyeing one more cut by the end of the year to a deposit facility rate of 1.75%. There are moderate chances that the ECB could cut further later on. Pricing, however, is mostly driven by sentiment surrounding US-EU trade relations, with tensions having risen again of late. The 9 July deadline to negotiate a deal is approaching fast, with limited progress visible so far.

Between tariff news and Germany’s fiscal U-turn at the start of March, markets have staked out a range for the perceived terminal deposit facility rate of 1.5% to 2%. Now, toward the lower end of that range, a slightly dovish tone from the ECB this week would likely not alter the bigger picture and merely keep us in the lower half of that range. We think it would rather need a string of weaker data to push rates more noticeably lower.

The downside in rates is still limited by the prospect of increased EU defence spending and fiscal stimulus out of Germany. That story may be moving to the background for now, but still-elevated, longer-dated real rates indicate it is still an important part of the markets’ calculations. The 5Y5Y implied real rate from euro swaps remains some 30bp higher than before Germany’s spending announcement. And since 'Liberation Day', this real rate has not nudged lower.

President Lagarde’s remarks during a speech last month introduced the idea of a “global euro moment,” suggesting that coordinated government efforts could boost the euro’s role on the international stage. This narrative may help explain the recent overvaluation in EUR/USD. If European policymakers keep pushing this agenda, strategic long positions in the euro could rise. Lagarde’s enthusiasm makes sense – a stronger, globally-embraced euro supports bond market stability, keeps borrowing costs low, and helps contain inflation. But exporters are already voicing concerns over the euro’s strength, and national governments with solid finances may be less eager to support the move, since they benefit from low borrowing costs.

A currency’s global appeal hinges on the depth of its bond market. To truly challenge the dollar, the euro needs a consistent strategy for ongoing common EU debt issuance. ING's Chief Economist Marieke Blom discusses this theme in detail in this note.

Any further indications that the ECB is favouring a globalisation of the euro despite its export-dampening side effects can trigger a positive EUR/USD response this week, potentially limiting the negative impact of a dovish surprise in the overall message.

Our view on EUR/USD remains that rallies beyond 1.15 will be quite hard to justify with weak US growth expectations alone and may well require a further material deterioration in the US Treasury market. Barring that, we think 1.13 can still prove to be the main anchor for the pair.