The disinflation is real, and the stance has not kept pace
Headline euro-area inflation has spent the better part of a year converging towards the 2% objective, and the composition of that decline is more reassuring than the headline alone. Goods disinflation has done its work, energy base effects have washed through, and the stickier component, services, is finally rolling over as wage settlements moderate from their post-energy-shock peaks. Negotiated pay growth, the metric the Governing Council watches most closely, has decelerated from above 5% towards the high-3s, a pace broadly consistent with target-compatible unit labour costs once one allows for a modest recovery in productivity.
Against this, the deposit rate has barely moved. With the policy rate around 3% and inflation expectations anchored close to 2%, the real ex-ante policy rate sits near 1.5%. That is materially above the range of neutral-rate estimates the ECB's own staff have published, which cluster between zero and 1% in real terms. In plain language: the stance is restrictive, and it is becoming more restrictive by inertia as inflation falls faster than the nominal rate. Holding still is not neutral when the denominator is moving.
This is the crux of our argument. The debate is too often framed as whether the ECB should ease. The more precise question is how much real tightening the Council is prepared to tolerate while it waits for confirmation it already largely has. Each month of delay is a passive tightening, and the lagged transmission of that stance into credit and investment is exactly what the Council claims to want to avoid.
Why 75bp, and why faster than the market expects
We expect the first cut at the March meeting, accompanied by a downward revision to the staff inflation projection for this year and next. The forecast round is the natural vehicle: it lets the Council frame easing as a mechanical response to a lower projected path rather than a change of conviction, which is the kind of cover a consensus-driven committee prefers. From there we look for follow-through in April or June and a third move before the September meeting, totalling 75bp.
The market, by contrast, is discounting closer to 50bp over the same window. We think that under-prices two things. First, the asymmetry of the Council's loss function at this point in the cycle. Having been late to tighten in 2021-22, the institution is acutely sensitive to being late to ease into a stagnating economy, with German industrial output still contracting and euro-area growth running below 1%. Second, the speed at which the real rate becomes punitive if inflation prints in the low-2s or below while the nominal rate is held. The Council does not need a recession to justify 75bp; it merely needs to decline to engineer one.
The external constraint is loosening rather than binding. With the Federal Reserve no longer the obstacle to European easing it appeared to be eighteen months ago, the euro has scope to absorb a moderate widening in rate differentials without disorderly weakness. A softer currency is, if anything, a tailwind the Council will not object to given the external sector's role in the growth outlook.
The title's second clause: why it will not be enough
Three cuts of 25bp take the deposit rate to roughly 2.25% by September. On unchanged inflation expectations that still leaves the real policy rate marginally positive and close to the upper bound of neutral estimates. In other words, even our above-consensus call describes an ECB that removes some restriction but does not reach a genuinely accommodative or even cleanly neutral stance within the forecast horizon. The Council will have eased, and the stance will remain a mild headwind to an economy that is barely growing.
This matters for how clients should read the easing cycle. A move to 2.25% is not stimulus; it is the partial unwinding of an overhang. For an economy carrying the structural costs of energy reconfiguration, weak demographics and a manufacturing base under competitive pressure from both Asia and a more protectionist United States, mild restriction is a meaningful drag. We therefore expect the cutting cycle to extend into 2027, with the terminal-rate debate eventually centring on whether the floor is nearer 2% or below.
The corollary is that the front end of the curve has further to fall than the September snapshot suggests, while the long end is anchored by a separate set of forces, chiefly fiscal supply, to which we now turn.
The counter-argument we take seriously: fiscal reflation
The honest risk to a duration-positive view is not that the ECB cuts less than we expect, but that the long end refuses to follow because the fiscal backdrop has structurally changed. Germany's relaxation of its constitutional borrowing limits, the pan-European push to rearm, and the capital intensity of the energy and digital build-out together imply a multi-year increase in core sovereign issuance. More supply, all else equal, lifts term premium and steepens the curve from the back.
If that reflation also revives growth and, with it, inflation expectations, the Council's room to ease shrinks and the terminal rate settles higher than the 2% area we have in mind. This is a coherent scenario and we do not dismiss it. Our response is one of curve positioning rather than direction. We are more confident in the front and belly, where the policy rate exerts gravitational pull, than in the 30-year sector, where fiscal supply and term premium dominate. The trade is to own duration where the central bank is the marginal price-setter and to be more cautious where the debt-management office is.
Fiscal expansion of this kind takes years to disburse and is front-loaded with planning, not spending. The cyclical disinflation playing out now is largely insulated from a defence build-out that lands in 2027 and beyond. The two stories can comfortably coexist: lower policy rates this year, a higher and steeper long end over the medium term.
Positioning the book around the call
We have moved euro fixed-income exposure modestly long of benchmark duration, concentrated in the 5-7 year part of the curve. This segment captures the bulk of the repricing as the policy rate falls while limiting exposure to the term-premium risk that the fiscal counter-argument identifies at the very long end. We pair this with a flattening bias in the 2s/10s relationship through the first half of the easing cycle, reversing towards a steepener as fiscal supply asserts itself later.
In credit, the macro picture, falling policy rates into a soft but non-recessionary economy, is constructive for carry. We prefer investment grade and the stronger end of European corporates, where all-in yields remain attractive in absolute terms even as spreads are tight, and where lower base rates ease refinancing. We are deliberately not reaching into the lowest-rated tier; the economy is too weak to underwrite a broad compression in default risk, and the marginal spread does not pay for the marginal fragility.
The clearest tactical instruction is to reduce cash. Money-market yields will fall faster than many clients expect once the cutting cycle is confirmed, and the opportunity to lock attractive yields further out the curve diminishes with each meeting. The reinvestment risk in holding euro cash through a 75bp move is the position's most underappreciated cost.
What this means for clients
First, extend duration deliberately rather than waiting for the first cut. By the time the March move is delivered and confirmed, the belly of the curve will already have priced much of the cycle. Clients holding large euro cash or short-dated balances should rotate a portion into the 5-7 year area to secure yields before they compress, accepting that this is a return-of-capital instrument as much as a return-on-capital one.
Second, treat the easing cycle as a reason to be invested, not as a market-timing signal. A policy rate falling to 2.25% and beyond erodes the comfort of cash and supports the relative case for quality credit and, selectively, for dividend-paying European equity where balance sheets are sound. The opportunity cost of sitting in deposits rises with every cut.
Third, hedge the fiscal tail rather than ignore it. For clients with long-dated liabilities or large allocations to the very long end of euro government bonds, the structural increase in sovereign supply argues for caution at the 30-year point and for diversifying duration across maturities rather than concentrating it. We would rather own the part of the curve the central bank controls than the part the treasury floods.
Finally, keep currency in view. A faster ECB and a softer euro have implications for clients with consumption or liabilities outside the euro area. Where spending is in sterling or dollars, this is an appropriate moment to review hedging policy, since the rate-differential dynamic that supports our duration call also weighs on the currency.
This note is house research and reflects the views of the Macro desk at the time of writing. It is not investment advice or an offer.
