The ECB not only surprised the market in April with a smaller then expected rate cut of 0.25% (25bps), it also failed to announce much-anticipated quantitative easing measures, though it is likely these measures will be discussed at the ECB’s May meeting.

The reluctance of the ECB to aggressively reduce rates towards zero, and keep the 1.0% differential between the refinancing rate of 1.25% and deposit rate of 0.25% has provided a degree of clarity around ECB intentions. It appears the central bank is happier working against the possibility of underestimating, rather than overestimating, deflationary risk, in order to encourage money market activity.

On this basis, Citi analysts have realigned their expectation on terminal interest rates for the ECB to stand at 1.0% rather than the previous estimate of 0.5%.

As pro-risk plays continue to favour the Euro (EUR) and cyclical currencies, the broader view that the decline of the global economy is beginning to decelerate, offers strength to the case for a reversal of EUR fortunes in the near term. However question marks remain over the scale or even implementation of Quantitative Easing up until mid-2009. With the fortunes of the US dollar testament to the effects of such policy, medium term performance of the EUR should be approached with caution.

With little known about the likely speed or timeframe of a return to global growth, market commentators broadly have greater confidence that a longer term weakening in the USD will play out favourably for the EUR.