The European Central Bank holds its policy meeting Thursday with markets pricing 72% probability of an unchanged deposit-facility rate at 2.50%, leaving only 28% odds of a 25 basis point cut, according to Reuters' analysis of overnight-index-swap pricing. The shift away from cut bets reflects March's Eurozone harmonized CPI print of 2.7%, well above the ECB's 2% target.
Eurozone Q1 GDP, scheduled for release Wednesday morning, is expected at +0.1% quarter-on-quarter, down from +0.2% in Q4. France and Germany — together approximately 50% of bloc output — are estimated at 0.0% and -0.1% respectively. Italy and Spain remain the relative bright spots at +0.3% each. The euro traded at $1.0732 on Monday, down 1.4% over the past five sessions and 4.2% YTD.
Stagflation in Plain View
The combination of rising headline CPI, weakening growth, and a slipping currency creates the textbook conditions of stagflation. ECB chief economist Philip Lane in an April 22 Berlin speech acknowledged that "the path back to 2% inflation has been delayed by external shocks," language that markets interpret as code for the Iran-driven oil shock. Goldman Sachs European chief economist Sven Jari Stehn expects the next ECB cut to slide from June to September, with a year-end deposit rate of 2.25%.
The Stoxx Europe 600 closed Monday at 561, up 0.3%, and is up 2.7% YTD, lagging the S&P 500's 4.2%. The DAX (15,318) and CAC 40 (8,184) trade flat for the year. Banks and industrials are the leading sectors; consumer-discretionary the principal laggard.
Sector Rotation Underway
European defense names continue to dominate flows. Rheinmetall (RHM.DE) is up 78% YTD, BAE Systems (BA.L) up 32%, Thales (HO.PA) up 41%, and Leonardo (LDO.MI) up 36%. Energy and utility names are running second. Banks BNP Paribas (BNP.PA), Santander (SAN.MC) and ING (INGA.AS) have outperformed the index thanks to wider net-interest margins, even as cut expectations recede.
Outlook
A hawkish hold from Lagarde would likely push EUR/USD toward $1.060, while a surprise cut would briefly weaken the euro before triggering an equity rally. The European fiscal-policy backdrop adds a layer: Germany's ramped-up defense and infrastructure spending plan implies a 2026 deficit of 4.1% of GDP, and a coordinated EU defense-industrial-base initiative is set for formal release at the June EU Council. The medium-term picture: a fiscal-led euro reflation that may eventually cap EUR/USD weakness, but is not yet in evidence.