In brief
- Diverging central bank policies are shaping distinct outlooks for the euro and UK markets, with the European Central Bank (ECB) nearing the end of its easing cycle and the Bank of England (BoE) expected to continue with gradual rate cuts later this year.
- Interest rates in the eurozone are now more neutral, and fiscal policy is expected to drive growth going forward. In the UK, rates are more restrictive but weak growth and signs of easing inflation paves the way for rate cuts.
- Persistent geopolitical tensions and trade policy volatility are influencing market sentiment, but euro credit markets have been resilient thus far.
- For cash investors, elevated terminal rates and persistent market volatility present compelling opportunities for active management and selective positioning, especially in resilient credit sectors like European financials.
As we reach the midpoint of 2025, European countries are navigating an increasingly complex and evolving economic landscape characterised by shifting inflation dynamics, fiscal policy tailwinds, and escalating geopolitical concerns. While both the ECB and BoE remain committed to their respective inflation targets, differences in their economic and inflation outlooks have led to a divergence in monetary policy. We believe that interest volatility and elevated uncertainty are influencing investor sentiment and creating opportunities for active portfolio positioning.
Euro area: Easing nears its end amid fiscal tailwinds
The first half of 2025 has been eventful for the eurozone. The ECB took proactive steps to reduce its deposit facility rate by 100 basis points (bps) via four interest rates cuts in the first six months of the year, supported by continued disinflationary trends. Since peaking in mid-2024, ECB interest rates have declined from 4% to 2% as inflation returned to the ECB’s medium-term target, economic growth moderated and global trade tensions magnified uncertainty.
Credit markets in Europe have remained resilient despite geopolitical headwinds and trade policy volatility. Spreads have performed well, signalling investors willingness to add risk , coupled with strong technicals. This constructive report on the balance of supply and demand clearly indicates recessionary concerns are not front of mind for European investors at this point in time.
With interest rates near neutral, we believe the easing cycle is likely nearing its conclusion, with only one additional cut potentially on the horizon, contingent on incoming growth and inflation data. While the interest rate environment is likely to remain volatile, fiscal policy is expected to provide a meaningful offset. Germany’s upcoming defence and infrastructure investments, expected to roll out in early 2026, will likely cushion growth and reduce near-term recession risks.
From an investment perspective, rate volatility continues to offer selective opportunities. Our focus remains on European financials, one of the more defensive asset classes in this environment, given their relative strength and ability to weather macroeconomic uncertainty.
UK: Poised for gradual easing as growth moderates
The UK enters the second half of 2025 with a more cautious approach to monetary policy. In the first six months of 2025, the Bank of England cut base rates by 50bps via two interest rate cuts as it balanced significant progress on disinflation versus lingering price pressures and a tight labour market. Since peaking in mid-2024, the BoE has now cut rates by a total of 100bps.
Inflation remains a primary concern, with headline core and services inflation still elevated. The BoE acknowledges “two-sided” risks, persistent wage pressures on one hand, and softening global trade and domestic consumption on the other.
Economic activity has been mixed. While Q1 saw a strong 0.7% quarterly growth rate, partially due to pre-tariff inventory buildups, April GDP contracted by 0.3%, suggesting a possible slowdown ahead. Meanwhile, the labour market is showing early signs of loosening, with payrolls down 0.4% in recent months. If sustained, this trend could relieve some inflationary pressure and support the case for easing.
At its June meeting, the BoE’s Monetary Policy Committee held the Bank Rate steady, however, the voting pattern and subsequent comments by Governor Bailey confirmed that the path to gradual easing appears increasingly likely.
We expect two further 25 basis point rate cuts in 2025, likely in August and November, with further easing possible in 2026 depending on macroeconomic conditions. While policy will remain moderately restrictive in the near term, we believe this trajectory opens up meaningful opportunities for positioning, especially in short-duration UK credit.
Conclusion: Implications for cash investors and portfolio strategy
Despite diverging monetary paths, both the ECB and BoE are navigating toward a more accommodative stance in response to moderating inflation and evolving economic conditions. For cash investors, the environment remains favourable, with terminal rates still offering attractive yields and inflation pressures gradually receding.
We are positioning our portfolios to take advantage of this backdrop by maintaining a moderate duration bias, with slightly greater emphasis on UK markets given their easing potential. We continue to favour high-quality short-term credit, particularly in the European financials sector, which offers strong fundamentals and defensive characteristics. We are leveraging rate volatility for tactical opportunities, while remaining vigilant of geopolitical risks and fiscal policy shifts.
As always, we believe active management remains critical in navigating a complex and dynamic rate environment, allowing us to preserve capital, capture yield, and adapt as conditions evolve.