ECB taking a breather, France’s budget falls short and China’s resilience

The ECB is expected to pause at its meeting on 24 July, holding the deposit rate steady at 2.0% after nearly 200bps of cumulative cuts. However, we anticipate two additional cuts in September and October before the cycle concludes, driven by inflation moving below target to 1.6% and continued weak economic momentum amid tariff-related uncertainty, a strong euro and softening US demand. Risks are asymmetric: A further escalation of US tariffs could prompt the ECB to cut rates below 1.5%, while a more resilient Eurozone economy – one that absorbs our baseline tariff assumption of 12% and the uncertainty shock better than expected – could justify a prolonged pause. In addition to euro strength, rising long-term bond yields are becoming a growing concern for policymakers. This could spark a debate on slowing the pace of quantitative tightening (QT). Halting QT could lower long-end yields by an estimated 20bps, strengthening the case for recalibration – especially as tighter financial conditions pose an added risk to an already fragile recovery.

Prime Minister Bayrou unveiled an ambitious fiscal package of EUR44bn – almost half in the form of tax hikes – to reduce the public deficit from -5.8% GDP in 2024 to -4.6% GDP in 2026. If implemented, it would knock -0.6pp off GDP growth in 2026. Without fiscal consolidation, France would need to grow by +2.3% to stabilize the debt-to-GDP ratio, which remains unlikely. But the fiscal package falls short in two ways: First, it relies on optimistic assumptions on healthcare saving and tax collection. Second, there is no clear and consistent strategy of structural spending cuts to achieve the target deficit of -2.8% GDP by 2029. Ultimately, it has a close to zero chance of passing Parliament and the most likely scenario remains a watered-down budget, or the absence of budget under a prolonged “Special Law”, which would generate half the savings (EUR20bn), reducing the deficit to 5.1% in 2026 from -5.5% expected in 2025.

The Chinese economy performed better than expected in the first half of the year, pushing up our full-year growth forecast to +4.8% (from +4.5%). But we keep 2026 at +4.2% as US tariffs will eventually bite and the domestic demand recovery could lose steam. The consumer trade-in scheme, which amounts to 0.2% of GDP, likely unlocked another 0.5% of GDP worth of household savings, keeping private consumption artificially high. Durable goods such as consumer electronics, personal household products and furniture have thus seen growth of beyond +30%. Yet, car sales have been much more modest and oversupply has led to strong deflationary pressures (-25% between mid-2021 and end-2024). To avoid continued deflation (we expect inflation at 0.2% in 2025), policy efforts should further shift from the supply to the demand side, as well as focus on stabilizing housing prices. In the long run, services could become a driver for domestic demand. The Politburo meeting by the end of July will provide hints on the policy direction for the rest of the year, while the China-EU Summit on 24-25 July as well as the 12 August deadline for the trade war truce with the US may influence how much external demand will continue to contribute to China’s economy.