Traders grew more confident on Thursday that the European Central Bank will deliver three more rate cuts this year as weak growth data followed by the bank's latest rate reduction highlighted the need for more easing.
The ECB cut rates by 25 basis points to 2.75%, as expected and kept the door open to further policy easing, helping push two-year German bond yields to three-week lows around 2.18%.
The bank's decision came hot on the heels of data showing the euro zone economy unexpectedly stagnated last quarter, falling short of expectations for a 0.1% expansion, as two straight years of contraction in Germany weighed on the bloc as a whole.
That added to the gloom as U.S. President Donald Trump's tariff threats cast a shadow on the outlook for the bloc's already sluggish economy, though he has so far not imposed blanket tariffs as feared.
Traders became more confident that the ECB would deliver three more rate cuts this year, now expecting 73 basis points of cuts by year-end, meaning more than a 90% chance of three cuts, slightly raising their expectations on Thursday.
Last Friday, they were pricing in around a 60% chance of three moves.
"There is really no reason to think the ECB won't continue to cut rates, at least to a neutral level, and we think quite probably below neutral by year-end," said Deutsche Bank (ETR:DBKGn) chief European economist Mark Wall.
Euro zone bond yields dropped with Germany's two-year yield, sensitive to interest rate expectations, set for its biggest daily fall since late November with falls of almost 10 bps.
Its 10-year yield, the benchmark for the euro zone, was down 7 bps to 2.50%.
The euro, which usually takes a hit from rising rate cut bets, was 0.1% higher on the day as the dollar weakened on the back of weaker-than-expected U.S. growth data.
The pan-continental STOXX 600 index was up 0.7%, relatively unmoved by the growth data or the ECB. An index of euro zone bank stocks held near its highest since 2011 it rose to earlier.
With the bloc facing a bleak outlook, some analysts said the ECB would have to cut rates below the 2% markets expect to see by year-end. That falls in line with estimates for the so-called neutral rate in the euro zone, which neither restricts or boosts growth.
"I think we’re going to go lower than that, question is how much lower," said Danske Bank (CSE:DANSKE) chief analyst Piet Christiansen, who expects the ECB to cut to 1.5%.
A March rate cut was "definitely" on the cards, Christiansen said, echoing market expectations of nearly a 90% chance of such a move.
"But what happens after that... we still have to see," he said.
