Analysis-For markets, German fiscal splurge blurs ECB outlook

By Yoruk Bahceli and Dhara Ranasinghe

LONDON (Reuters) – A tectonic shift in German fiscal policy has compounded uncertainty for traders trying to bet on how fast the European Central Bank will cut rates for the rest of the year, with a change to the bank’s guidance on Thursday reinforcing that.

The ECB cut rates by 25 basis points to 2.50% in its sixth move since last June. But it said that monetary policy was becoming “meaningfully less restrictive,” rather than the “restrictive” used before.

That supported traders, who had already reduced bets on ECB rate cuts after a deal from Germany’s next coalition partners on Tuesday to create a 500 billion euro ($541.40 billion) infrastructure fund and overhaul borrowing restrictions, partly to boost defence spending.

“We could have potentially one more cut, a maximum of two,” said Aviva Investors senior economist Vasileios Gkionakis, noting the ECB’s change in language was a win for the policy hawks and meant to signal that an end to rate cuts is coming.

Following the ECB’s meeting, traders further curbed their bets on an April rate cut, now seeing less than a 50% chance of a quarter point move, down from over 60% last week.

Indeed, policymakers also see a growing chance of an April pause before they lower rates again, once there is greater clarity about trade and fiscal policy, sources told Reuters.

By year-end, traders price in around a 60% chance of two rate cuts to follow Thursday’s, having priced in a chance of a third move last week.

FISCAL VS MONETARY BOOST

Markets are hoping Germany’s bold move to rip up its fiscal playbook may be a game-changer for Europe’s economy.

The euro surged to $1.0854 on Thursday, the highest since November 6, the day after U.S. President Donald Trump’s election, and well above the near $1.01 levels seen in February, as tariff worries weighed.

Germany’s bond yields, the benchmark for the euro zone, were set for their biggest weekly jump since the early 1990s as markets braced for a surge in borrowing.

Remarkably, traders have even moved to price in the chance that the ECB will start to raise rates again next year, given that the fiscal boost could lift inflation, seeing a roughly 40% chance of a hike by September 2026.

With little detail available and the German proposal yet to be approved, it wasn’t a factor for the ECB’s decision on Thursday, but it further blurs the monetary policy outlook, which analysts had already seen as less certain.

“If you throw that much money into an economy, you are going to get quite a difference. It also means inflation will be higher,” said RBC BlueBay Asset Management chief investment officer Mark Dowding.