Fast reading
- The ECB cut interest rates by 25bps on Thursday, taking its benchmark rate to 2.25%. ECB President Christine Lagarde expressed wariness about the impact trade tensions could have on business investment and consumer confidence.
- The European banking sector – which makes up a significant proportion of euro-denominated money market funds’ (MMF) credit – remains very healthy from a balance sheet perspective, putting MMF in a strong position to outperform the ECB rate and provide a premium on the banking sector’s overnight rates.
The European Central Bank (ECB) cut interest rates by 25bps on Thursday amid a backdrop of the global market rout driven by US President Donald Trump’s tariff scheme and a rally in the value of the euro.
Policymakers have to grapple with the expected economic slowdown from the tariffs, as well as a fallout from the market volatility which is likely to affect prices.
The cut – the seventh consecutive reduction – takes the ECB’s benchmark deposit facility rate to 2.25% (in mid-2023 it was 4%). Another cut is widely expected in June.
The EU – which has a €198.2bn trade surplus with the US – is expected to face ongoing hostility from the Trump administration over its trading relationship. In March, the ECB cut its 2025 growth forecast for the eurozone to 0.9%.
In Thursday’s press conference, ECB President Christine Lagarde said the global economic outlook is clouded by “exceptional uncertainty”.
“The major escalation in global trade tensions and associated uncertainties will likely lower euro area growth by dampening exports, and it may drive down investment and consumption,” she said.
Euro MMF
Gary Skedge, head of sterling and euro liquidity strategies at Federated Hermes, points out that Lagarde expressed optimism that inflation will continue to fall – and hit the ECB’s 2% target – but sounded wary about the impact that trade tensions could have on business investment and consumer confidence. Inflation in the eurozone was 2.2% in March, compared with 2.3% in February.
In a falling rate environment, money market funds can potentially offer additional benefits, providing ‘carry’ on higher rates (compared to sovereign debt, for example) while at the same time also providing daily liquidity – allowing investors ‘same day’ access all their cash.
The primary objective of any money market fund is capital preservation: investing in a diversified pool of highly-rated, short-term debt securities in order to achieve a competitive rate of return – no matter how volatile the underlying markets are.
The European banking sector remains very healthy from a balance sheet perspective, putting euro-denominated money market funds in a strong position.
“In terms of euro-denominated money market funds (MMF), the European banking sector – which makes up a significant proportion of their credit – remains very healthy from a balance sheet perspective, putting euro-denominated MMFs in a strong position to outperform the ECB rate and provide a premium on the banking sector’s overnight rates,” Skedge says.
Figure 1: Implied overnight rate and number of forecast ECB hikes/cuts
More cuts ahead
The market forecasts a further 75bps worth of cuts over the course of this year, bringing rates to around 1.5% by December 2025.
“While the tariff picture is rapidly evolving, there is no doubt that macro volatility is increasing downside risks for economic growth in the near term,” says Orla Garvey, Senior Fixed Income Portfolio Manager at Federated Hermes Limited.
In March, German lawmakers approved a €500bn spending package that could have a big impact on the defence and infrastructure sectors in Europe’s biggest economy. However, the impact of the ramp-up in German fiscal spending will not be felt until 2026, Garvey adds.
“In contrast to the US, the deterioration in the growth outlook in Europe doesn’t come with the same upward inflationary impulse. In fact, it is likely the opposite, which will give the ECB greater confidence in its inflation forecasts and keep it on track with its cutting schedule,” she says.
Share:
BD015778
