ECB to Deliver a Hawkish Cut

• ECB widely expected to trim the policy rate 25bps to 2.50%. ECB will likely signal limited room for further easing which bodes well for EUR in the near-term.
• Sweden CPI inflation ran hot in February. Riksbank unlikely to ease policy further. SEK outperforms.
• Japan’s biggest trade union group is demanding larger wage hikes. BOJ could be forced to step-up pace of policy normalization. 10-year JGB yields surged to fresh multi-year highs.

USD remains under broad downside pressure. The prospect for looser fiscal policy in the Eurozone has shifted the relative economic growth dynamic in favor of EUR. Global bond markets continue sell off and European stocks are extending their rally triggered by Germany's plan to boost fiscal spending.

Tariffs roller coaster takes another twist. After hitting Canada and Mexico with 25% tariffs on Tuesday (with a reduced 10% rate for Canadian energy), the Trump administration announced Wednesday that the 25% tariffs on autos and auto parts traded through the North American trade pact USMCA would be paused for one month. Prime Minister Justin Trudeau said Canada won’t lift counter-tariffs unless all US levies are lifted. USD/CAD and USD/MXN have now retraced all the gains caused by the initial US executive order on February 1 to impose duties on Canada and Mexico.

The Fed Beige Book suggests the barrage of tariff announcement has not yet shaken confidence in the US economy but points to upside risk to inflation. “Overall expectations for economic activity over the coming months were slightly optimistic…Employment nudged slightly higher on balance...Contacts in most Districts expected potential tariffs on inputs would lead them to raise prices, with isolated reports of firms raising prices preemptively.” The Beige Book was compiled using information gathered on or before February 24.

Meanwhile, the forward-looking ISM services index was surprisingly strong. In February, the headline index rose 0.7pts to 53.5 (consensus: 52.5) indicative of a faster expansion in US services sector activity. The details reinforced the case for a cautious Fed easing cycle. The New Orders Index was up 0.9pts to 52.2, the Employment Index improved 1.6pts to 53.9 (the highest since December 2021), and the Prices Index increased 2.2pts to 62.6.

We remain constructive on the US growth outlook but the consumer spending contraction in January is a red flag. The strength of the labor market will decide whether the poor data in January was just a blip or the start of a deeper downturn. Friday’s February non-farm payrolls data will be key. Non-farm payrolls are expected at 160k vs. 143k in January, consistent with a healthy labor market. Softer than expected February ADP private employment gains (actual: 77k, consensus: 140k, prior: 186k) and recent government layoffs suggest risks to non-farm payrolls are skewed to the downside. Still, it’s worth noting that total federal jobs account for less than 2% of total non-farm employment. Bottom line: USD will continue to trade on the defensive until we have evidence the US labor market remains in solid shape.

The US January trade balance of goods and services is due today (1:30pm London). In December, the annual trade deficit totaled -US$918bn vs. -885bn in November. Trade imbalance is a key input in the Trump administration’s tariff decision. Indeed, the Trump administration’s tariff announcements mainly target countries where the US runs large goods trade deficits. The US biggest cumulative goods trade deficits are with China and the European Union at -US$285bn and -US$226bn, respectively. The US cumulative goods trade deficits with Mexico and Canada are also significant at -US$174bn and -US$73bn, respectively.

The Atlanta Fed Q1 GDPNow model will be updated today after the international and wholesale trade data. The model is currently tracking at -2.8% SAAR, down from -1.5% on February 28. Fed speakers today include: Philadelphia Fed President Patrick Harker (2026 FOMC voter) (1:45pm London), and Fed Governor Christopher Waller (8:30pm London).

EUROZONE

EUR continues to power forward versus USD and GBP underpinned by Germany’s big fiscal thrust announcement on Tuesday. The prospect for looser fiscal policy in the Eurozone lessens the need for the ECB to do the heavy lifting in supporting growth. Interest rate futures have adjusted accordingly to imply less ECB easing over the next twelve months (60bps vs. 90bps on Monday).

The ECB policy decision (1:15pm London) and President Christine Lagarde’s press conference (1:45pm London) take the spotlight today. The ECB will also publish updated macroeconomic projections. The ECB is widely expected to cut the policy rate 25bps to 2.50%. The ECB is also expected remove reference that monetary policy remains restrictive because the policy rate is getting close to neutral rate territory. ECB staff estimate the neutral rate at 1.75%-2.25%. Scrapping the restrictive reference would signal limited scope to ease policy more than is currently priced-in and offer EUR support.

UK

GBP/USD rallied to near a four-month high above 1.2900 on USD weakness. Today, the UK February DMP survey of inflation expectations (9:30am London) will likely validate the BOE’s guidance for “a gradual and careful approach” to further rate cuts. 1-year expectations is expected to rise 0.1pts to an 11-month high at 3.1% and remain well above the series lows of 2.5% in October 2024. Over the next 12 months, the swaps market is pricing in 50bps of BOE rate cuts to 4.00%.

SWEDEN

SEK is outperforming. Inflation in Sweden quickened more than anticipated in February, suggesting the bar for additional policy rate cuts is high. The policy relevant CPIF rose 0.7pts to a one year high at 2.9% (consensus: 2.7%, Riksbank forecast: 2.2%) while CPIF Ex-energy rose 0.3pts to 3.0% (consensus: 2.7%, Riksbank forecast: 2.4%). The Riksbank projects the policy rate to bottom at the current level of 2.25%. Markets have adjusted towards the Riksbank’s forecast after pricing-in a lower terminal policy rate of 2.00% ahead of the CPI data.

JAPAN

USD/JPY is breaking lower as Japan 10-year yields overshot 1.50% for the first times since 2009. Japan’s biggest trade union group, known as Rengo, is demanding larger wage hikes. Members are asking an average wage increase of 6.09% this year, up from last year’s 5.85%, and seeking more than 6% for the first time in more than three decades. Faster wage growth is an upside risk to Japan’s inflation outlook and could force the Bank of Japan to normalize rates by more than is currently priced-in (40bps over the next 12 months).

TURKEY

Turkey central bank meets today and is expected to slash rates 250bps to 42.50% (11:00am London). The bank has cut rates by 250bps at its last two meetings as inflation pressures eased. Headline CPI and core CPI eased to near a two-year at 39.05% y/y and three-year low at 40.21% in February, respectively. The swaps market is pricing in 1575bps of total easing over the next 12 months that would take the policy rate to 29.25%, but this may be optimistic if inflation continues to overshoot the bank’s year-end forecast of 24%.