ECB remains comfortable with its balancing act, while keeping a close eye on EUR

Highlights: The European Central Bank (ECB) held rates unchanged in a unanimous decision, confirming that the balancing act between growth, inflation and rates keeps it in a “good place,” while monitoring two-sided risks to the outlook. While economic activity has been stronger than expected, inflation recently undershot the target at 1.7 per cent. We hold a positive view on EUR against USD, as we view the currency as a beneficiary of global diversification flows, rather than of narrowing rate differentials in light of the new Fed Chair nomination. A stable policy outlook should still support EUR credit, underpinning our preference for investment grade issuers.

• ECB President Lagarde acknowledged that there are two-sided risks to the outlook. On the one hand, frictions in trade and lingering geopolitical risks could affect demand through the sentiment channel. But on the other hand, a planned ramp-up in defence and infrastructure spending, along with the adoption of new technologies could also add upside risks to growth
• While the Governing Council is keeping an eye on exchange rate moves, it highlighted that most of the US dollar depreciation occurred prior to last summer, meaning that EUR strength has already been incorporated in its baseline scenario. As such, the recent inflation undershoot does not alter their expectation for inflation stabilising around 2 per cent over the medium term. This statement contributed to a mild pick-up in yields and EUR, however the overall market reaction to the meeting remained relatively contained, as the market continues to price in no changes in policy rates for the rest of the year
• While we continue to view peripheral spreads well anchored, we recently took profits here to reallocate more to Gilts on relative valuations. The BoE’s closer-than-expected decision coupled with lower inflation forecasts continues to support our argument of gradual cuts that could support the Gilt market accordingly
• We keep a neutral view on European equities as the region remains sensitive to unfolding geopolitical developments in the short term but continue to seek opportunities in policy beneficiaries such as Industrials and Utilities, while maintaining an overweight view on regional Financials