ECB policymaker Francois Villeroy de Galhau has said that further rate cuts are possible, even with the current economic situation. He noted that inflation expectations are moderate and recent oil price hikes have offset some gains from a stronger euro. Villeroy mentioned that a ceasefire between Iran and Israel could result in changes to policy within the next six months, but he emphasized that oil prices alone won’t dictate the ECB’s decisions.

Neutral And Terminal Rates

He explained that the neutral rate and the terminal rate are different. The ECB plans to observe how things unfold before making further moves. Currently, markets expect about 23 basis points of rate cuts by the end of the year. The ECB is staying flexible and hasn’t committed to immediate changes. Villeroy’s comments provide insights into the euro-area’s monetary policy future. His focus on the neutral rate versus the terminal rate indicates that the central bank hasn’t reached its final goal yet. The neutral rate is an estimate of a balance point that neither boosts nor slows the economy, while the terminal rate is where rates might eventually settle after a cycle of increases or cuts. Differentiating between these rates helps us understand the ECB’s cautious approach. Villeroy also pointed to geopolitical risks, particularly the potential ceasefire between Iran and Israel, indicating that the bank is analyzing factors beyond usual inflation signs. He suggested that while energy prices, like crude oil, may temporarily affect overall inflation, they won’t drive decisions alone. This important nuance shows that supply-side shocks, such as oil prices, will be evaluated alongside domestic demand and wage trends.

Market Expectations And Strategy

Market expectations are pricing in nearly one-rate cut before the year ends, around 23 basis points. This aligns with our assessment: traders are cautiously leaning towards continued easing. The ECB’s lack of specific future guidance shows they do not want to commit until they have clearer data. What’s noteworthy is not just what Villeroy said, but the tone of his speech. It was careful and designed to keep options open without offering false certainty. This serves as a reminder for us to stay flexible. This cycle does not lend itself to simple assumptions. Rate expectation changes will likely be gradual and contingent on factors beyond basic inflation, like global events and commodity movements. In the coming weeks, this suggests a more measured approach when betting on rate movements. Short-term volatility is still more influenced by words than actions. Traders looking for volatility may find fewer opportunities unless macroeconomic indicators surprise significantly. Those trading duration might prefer smaller, steady positions, especially around important data releases or central bank updates. If oil prices change direction or wage growth speeds up, the curve could steepen quickly. We need to monitor these turning points closely. Long-term contracts might currently price in overly cautious expectations—something to compare against past ECB reactions. Data will be more crucial than usual this summer. European PMIs, wage agreements, and regional inflation figures from places like Germany or Belgium could carry extra weight. Therefore, positioning should be lighter but more strategic, focusing on short opportunities when event risk sways probabilities. In such times, flexibility is not just a strategy—it’s essential. One or two well-timed decisions could significantly alter market rate perceptions. This highlights the importance of clear communication from policymakers, allowing us to create responsive probability assessments rather than mere forecasts. Create your live VT Markets account and start trading now.

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