Yield outlook: Optimism about Europe is broadening

European rates continued to rise in late July and into August – fortunately, on a positive note.
The trade policy disputes with the Trump administration culminated in an agreement at the end of July, providing essential clarity for European businesses. While the agreement entails a general 10 percentage point increase in tariffs on imported European goods to the US, more crucially, it removes the risk of a larger trade war. This alone has bolstered the economic outlook in Europe and led to higher market rates.

Fiscal tailwinds could arrive sooner than expected in Germany

With the threat of a trade war removed or at least reduced, Europe’s focus has now shifted to the forthcoming investments in infrastructure and defence, which could become a key driver of growth in the coming years. In Germany, the government reached an agreement on the 2026 budget draft at the end of July, which will include a significant increase in public investments starting as early as late 2025. Alongside these investment plans, the government’s so-called ‘growth booster’ initiatives – including more lenient depreciation rules and subsidies – aim to enhance support for German businesses. We believe that the government’s plans, if approved by parliament in September, have the potential to provide a more substantial boost to euro area growth next year than previously anticipated.

ECB has more reasons to keep rates steady

For the ECB, the shift from trade policy uncertainty to fiscal optimism is significant for risk assessment within the Governing Council. At its July meeting, the central bank was notably positive about the economic outlook, identifying a trade war with the US as the single greatest risk to the economy at that time. This was, notably, before the trade agreement with the US was finalised and prior to the German government’s budget proposal. Meanwhile, economic data from Europe have continued to improve, with a particularly notable reversal of the downward growth signals from the services sector. We think that the likelihood of further ECB rate cuts has significantly diminished over the summer, and we therefore expect the key policy rate (the deposit rate) to remain at 2% until the end of 2026.

In the near term, the risk for short-end EUR rates remains tilted towards one final rate cut. European wage data still point to a significant decline in the coming quarters, which could create room for slightly easing monetary policy further. However, based on recent statements from ECB members, diminishing wage pressures do not appear to be a major concern for the majority, and the threshold for additional rate cuts now seems considerably higher following the developments of the past month

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