The European Central Bank (ECB) lowered its key rates by 25 basis points in June 2025. The deposit facility rate is now at 2.00%, steady from expectations but down from 2.25% previously. The main refinancing rate is now 2.15%, which meets expectations but is reduced from 2.40%. The marginal lending facility rate has decreased to 2.50%, down from 2.65%. Inflation is projected to align with the medium-term target of 2%, with expectations of 2.0% for 2025, 1.6% for 2026, and returning to 2.0% in 2027. Core inflation is estimated at 2.4% for this year and will settle at 1.9% for the following two years. Real GDP growth is forecasted to be 0.9% in 2025, 1.1% in 2026, and 1.3% in 2027.

Monetary Policy Approach

The ECB is taking a data-driven approach, deciding on rates from one meeting to the next without sticking to a preset course. Recent forecasts show little change in economic outlooks, with core inflation steady. Changes in headline inflation are due to falling energy prices and a stronger euro. The decision had little effect on EUR/USD, which stayed at 1.1423. The expected rate cut signals the ECB’s belief that price pressures are easing according to their targets. President Lagarde is cautious, preferring to review each meeting individually without committing to any specific direction. This choice highlights a desire to stay flexible rather than lock in a path that may not fit future data. Currently, stable price forecasts suggest that policymakers think the economy can sustain growth while gradually controlling inflation. The lower inflation forecast for 2026, dropping to 1.6%, supports this view. The slow increase in GDP growth over the next two years, while modest, indicates that the rate cut is more of a fine-tuning strategy than a reaction to immediate threats.

Market Expectations and Strategy

This situation does not suggest aggressive easing in the near future. Earnings growth is still being watched, and while services inflation is decreasing, it remains important in core figures. The euro’s strength against the dollar reduces import costs, easing pressure on headline inflation. However, if this continues, it may tighten financial conditions more than desired. Given this context, market expectations for the near term seem stable. Rate cut expectations have gradually entered the market and are mostly factored into interest rate futures. Unless new data significantly deviates from forecasts—either by showing slowed growth or a resurgence in core prices—volatility should remain low. Expect increased sensitivity at the short end of the market rather than in the middle or long term. Rate swaps and short-term interest rate (STIR) contracts may see slight adjustments after minor surprises in inflation data, but a significant change across the curve will likely need new forward guidance or a break in the current trend. There’s room to leverage flatteners within a given range, especially for the September and December contracts. Keeping this in mind, pursuing short-dated gamma may be less attractive compared to maintaining a neutral vega until clearer direction signals appear. The stability in EUR/USD indicates that FX volatility sellers are not facing challenges, and this situation won’t likely change unless U.S. data leads to differing policies stateside, which wouldn’t be evident through rate differentials alone. In conclusion, the fundamental assumptions remain solid—economic conditions are stable and inflation is gradually moving toward the target. The ECB has neither increased urgency nor removed options, creating an environment that favors tactical approaches led by inflation trends and real yield shifts, particularly in short-term positioning. Create your live VT Markets account and start trading now.

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