The new European security order has become the main market driver. This week, European equities continued to outperform the US, driven by defence stocks. At the time of writing, the German 10y yield was up 20bp on the week, diverging from US rates developments. Euro was up more than 4% against the dollar. The optimism in European assets reflects expectations of a massive defence expenditure boost. This week, the European Council decided on creating a new European instrument, up to EUR 150bn in loans from the EU to member states. Additional flexibility within the Stability and Growth pact is expected to enable EUR 650bn in investments, while the EIB’s expected mandate extension should improve access to private capital.
Danske Bank published its updated macroeconomic projections this week. Regardless of all the uncertainty, the cyclical story has not changed much, see Normalising economies despite the noise, 5 March. The disinflationary process is still on the way, rates are on decline, and labour markets are cooling. All Nordic economies are expected to recover this year but divergence in pace remains. The US economy, despite cooling down, is projected to grow by 2.3% this year, while growth in euro area is projected to remain slightly below 1%. Increased defence spending in euro area is an upside risk to growth, not least in Germany where the Parliament is expected to approve sizable fiscal packages next week, while also relaxing the debt brake. If implemented, these measures will boost the German economy, but the effects will be felt next year at the earliest. Read more on Euro Area Macro Monitor – Diverging signals as Germany proposes historic changes, 7 March.
The ECB cut its policy rates by 25bp this week, bringing the deposit rate to 2.5%. Importantly, the ECB adjusted its message saying that “monetary policy is becoming meaningfully restricted“. As we read it, although this week’s decision was still a consensus, it is likely that some Governing Council members would soon prefer at least a pause. The spillover from a broader rally in European assets prior to the ECB meeting had already led to markets pricing out one ECB cut for this year. Currently, markets price only two additional cuts for this year, and 19bp for April. As the disinflationary process is intact (Monday’s February flash print confirmed that) and as the positive growth impact from additional fiscal spending in Europe will take time to materialise, we keep our call unchanged. We still see the ECB cutting deposit rate to 1.5% by September.
Tariffs also made headlines this week. The US tariffs on goods imported from Mexico and Canada were initially raised to 25% on Tuesday, but by the end of the week, Trump had signed orders that exempted most goods until early April. The additional 10% tariff on Chinese goods that entered into force this week remains in place, and China has retaliated with tariffs targeting US farmers. This week, China announced it will stick to its 5% growth target this year and will use stimulus to counterbalance the negative impact from US tariffs.
Next week will be quiet on the data front. The Chinese CPI data will be released early on Monday. On Wednesday, we will get the US February CPI data, and on Friday, the Michigan consumer survey for March will be released. In geopolitics, we will keep an eye on the US-Ukraine meeting in Saudi Arabia on Wednesday.
