Traders Anticipate ECB's Steady Rates Amid Euro Observations

ECB's Interest Rate Decision and Market Reactions

By Samuel Indyk and Stefano Rebaudo

Impact of Currency Movements

LONDON, Feb 5 (Reuters) - Euro zone markets remained confident on Thursday in the view that the European Central Bank would likely hold interest rates steady for the rest of the year, with euro strength likely remaining in the spotlight.

Market Predictions and Economic Outlook

Speaking after the ECB left its key rate unchanged at 2%, central bank chief Christine Lagarde played down the impact of dollar moves on its future policy choices and stressed that its inflation outlook remained largely unchanged.

Traders' Expectations for Rate Changes

While economic data has held up, the dollar's recent tumble, volatility in commodity markets, U.S. President Donald Trump's war of words over Greenland and his pressure on the Federal Reserve to cut rates, highlight how the situation could quickly change.

Bond Yields and Stock Market Response

"We believe policy rates will remain at the current levels at least through the first half of 2026," said Allianz Global Investors senior rate strategist Massimiliano Maxia.

"The outlook could change, even quickly, if the economic backdrop shifts, or new geopolitical tensions arise," he said. 

"However, we are positive on the euro area economy this year, which has shown resilience despite tariffs and will benefit from the positive effects of increased German spending."

Traders still priced in around a 20% chance of an ECB rate cut by September, unchanged from earlier on, and an about 10% chance of a rate hike by April 2027.

The euro was largely steady at around $1.18. 

Rate-sensitive two-year government bond yields dipped briefly, although there was also downward pressure from a fall in British government bond yields following a dovish Bank of England policy meeting earlier on Thursday.

The yield was last trading at 2.07%, little changed on the day, while Germany's 10-year bond yield, the euro zone benchmark, was steady at 2.86%. 

"We think the ECB is in a good place now with monetary policy and most people agree with that, not least the ECB," said Tommy von Brömsen, FX strategist at Handelsbanken, who expects the central bank to keep rates on hold through 2026.     

European stocks were also broadly unchanged after the ECB decision. The pan-continental STOXX 600 was last down 0.5%. 

DON'T IGNORE THE EURO 

Lagarde said the central bank had no exchange rate target but keeps a close eye on the currency, stressing that dollar weakness against the euro should be seen in the context of the past year not just a few weeks. 

In the past year, the euro has gained around 13% against a broadly weak dollar, briefly breaking above $1.20 last week. 

Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management, said references to the euro in the ECB's policy statement and at the press conference were notable.

"I noticed changes in the way they (ECB policymakers) mentioned the exchange rate, which suggests that the ECB is looking at the currency more closely than before," he said.

"Also, in their statement the ECB added that the stronger euro is a risk to activity, this was not there in December."

Ducrozet added, however, that the bar to a further rate cut was high.    

(Reporting by Samuel Indyk, Stefano Rebaudo and Dhara Ranasinghe; Writing by Dhara Ranasinghe ; Editing by Amanda Cooper and Andrea Ricci )