As former European Central Bank president Mario Draghi once said: "In a dark room, you move with tiny steps. You don’t run, but you do move." Recent events over the last few weeks have reminded us of these famous words. The never-ending back and forth on tariffs, renewed geopolitical tensions and Europe’s seismic shift in defence spending, as well as Germany’s fiscal ‘Zeitenwende’, have led to significant moves in financial markets. The problem, however, with these kinds of announced policy shifts is that it’s not always clear when – or even if – they’ll actually be implemented. As a result, the impact on the real economy and central banks is not always so straightforward.
Take Europe for example. Yes, the German parliament yesterday agreed on changes to the fiscal debt brake and a large fiscal package on infrastructure and defence spending. Still, the details aren’t totally clear yet. We know that the multiplier for infrastructure spending is around one. But we’re also keeping in mind that – as important as it is for European security – defence spending will be something of a slow burner for growth across Europe. Production capacities need to be increased to get the best possible real economic impact from higher defence spending. And this will take time. Will the ECB then react to the potentially inflationary impact of higher infrastructure and defence spending, or will it respond to the more imminently looming US tariffs?
We received many questions on what the significant policy shifts in Europe mean for our macro and market forecasts. Here is our answer: we have updated our main forecasts, with a slightly more optimistic growth scenario for the eurozone, somewhat heightened inflationary pressures and an ECB that will stop cutting rates at a deposit rate of 2.25% this summer. At the same time, huge fiscal changes in Europe, led by Germany, will continue pushing up government bond yields over the next quarters, seeing German 10y bond yields breaching the 3% level.
You’ve heard it before, but we won’t get tired of repeating that we’re now living in times of unprecedented uncertainty, with a wide range of possible macroeconomic outcomes. This is the dark room Mario Draghi talked about. We could do nothing and just wait until someone turns on the light again. Or we could do it like European policymakers should, and follow Draghi’s example: moving with tiny steps, presenting our updated forecasts, still knowing that it’s unlikely to be the final revision made this year.
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Disclaimer: This publication has been prepared by ING solely for information purposes irrespective of a particular user’s means, financial situation or investment objectives. The information does not constitute investment recommendation, and nor is it investment, legal or tax advice or an offer or solicitation to purchase or sell any financial instrument.