European equity markets surged on Tuesday, with the pan-European STOXX 600 index climbing 1.4% to reach its highest level in six weeks, as softer-than-expected inflation figures from the eurozone’s largest economies renewed investor optimism over imminent European Central Bank rate cuts.
Germany’s DAX led the gains, rising 1.7%, while France’s CAC 40 added 1.5% and Italy’s FTSE MIB gained 1.3%. The rally was broad-based, with financials, industrials, and technology stocks all posting solid advances.
Inflation Surprise Drives Sentiment
Flash estimates released Tuesday showed eurozone consumer price inflation falling to 2.1% year-on-year in May, down from 2.3% in April and below the 2.2% consensus forecast. Core inflation, which strips out volatile food and energy prices, also eased to 2.4% from 2.7%.
“This is exactly the kind of data the ECB has been waiting for,” said Marie-Claire Fontaine, chief European economist at Société Générale. “It meaningfully increases the probability of a rate cut at the June meeting, and markets are pricing that in aggressively today.”
Interest rate futures now imply a roughly 85% probability of a 25 basis point cut at the ECB’s June 5 meeting, up from around 65% before Tuesday’s data release.
Bond Markets React Sharply
European sovereign bond yields fell sharply in response. The yield on German 10-year Bunds dropped 8 basis points to 2.31%, while Italian 10-year yields fell 11 basis points to 3.67%, tightening the risk premium that investors demand to hold peripheral eurozone debt.
The euro also weakened modestly against the US dollar, slipping 0.3% to $1.0842, as lower rate expectations weighed on the currency.
Sector Highlights
Real estate investment trusts were among the day’s biggest gainers, jumping 3.2% as investors anticipated the positive impact of lower borrowing costs on property valuations. Utility stocks gained 2.1% for similar reasons.
Banking stocks rose despite the prospect of compressed lending margins, with investors betting that improved economic growth would outweigh the negative effect of lower rates on net interest income. BNP Paribas gained 1.8%, Deutsche Bank rose 2.1%, and UniCredit added 1.6%.
Energy stocks were the notable laggard, slipping 0.4% as crude oil prices edged lower on demand concerns following weak manufacturing data from China overnight.
Outlook
Analysts cautioned that while the inflation data was encouraging, the ECB would likely remain cautious about committing to an extended easing cycle. “One good print doesn’t make a trend,” noted Lars Petersen, strategist at Nordea Markets. “President Lagarde will almost certainly keep options open for the July meeting rather than pre-committing to further cuts.”
Markets will now turn their attention to the ECB’s quarterly staff projections, due alongside the June rate decision, for clues on the medium-term policy path.