The ongoing disinflation and political uncertainties shaped the development of financial markets. Against the background of further improvements in inflation data and weaker economic signals, market participants initially adjusted their policy rate expectations for the United States and the euro area significantly downwards. For a time, market participants considered a pronounced rate-cutting cycle and thus an early end to restrictive monetary policy likely. Subsequently, ten-year yields in the capital markets of major currency areas fell quite sharply. The beginning of the fourth quarter saw market participants’ medium term expectations of policy rate cuts being dampened by unexpectedly robust labour market and economic data as well as the prospect of potentially high US budget deficits. Term premia for longer-term US bonds increased, too. This rise was also transmitted to interest rates in the euro area to a limited extent. At the end of the reporting period, the yields of ten-year government bonds presented a mixed picture compared with their end-June figures. However, the yield spread between the United States and the euro area increased. This contributed significantly to a depreciation of the euro against the US Dollar. In effective terms, the euro has also depreciated on balance against 18 trading partners.

Differing economic outlooks were clearly reflected in the international equity markets, with strong price gains in the United States and losses in the euro area and Japan. The nascent rate-cutting cycle and investors’ risk appetite, which has been growing again since mid-August, supported equity prices worldwide. In the United States, the asset prices of listed companies increased significantly. Market participants expect that the profits of listed companies, mainly those of financial corporations, will benefit from the new US administration’s policies. By contrast, lower earnings expectations and the prospect of impending tariffs dampened equity price developments in the euro area. Amid growing risk appetite amongst investors, the yield spreads of long-term government bonds in the euro area fell, as did those of corporate bonds, in particular.

On balance, the euro has depreciated against the US dollar since the end of the second quarter of 2024. Overall, developments in the euro-US dollar exchange rate since the end of June 2024 have mainly been influenced by expectations regarding US monetary policy and the outcome of the presidential elections in the United States. The Federal Reserve made it clear over the summer that it saw noticeable progress being made in combating inflation and thought the time had come to ease the degree of monetary policy restriction. The interest rate differential between the United States and the euro area declined during this period and the euro appreciated. At its meeting in mid-September, the Federal Reserve then cut key interest rates sharply by 50 basis points. The euro was trading at US$1.12 at end-September, the highest level seen in over a year. However, surprisingly positive US labour market data subsequently pointed to the US economy remaining robust. Market participants therefore considered a further 50 basis point cut by the Federal Reserve at one of its next meetings, which had been priced in for a time, to be fairly unlikely. This resulted in a downward movement of the euro that continued when the Eurosystem – contrary to expectations one month earlier – cut interest rates in mid-October in response to increasingly disappointing economic data in the euro area. In addition, the sharp rise in US capital market interest rates, particularly in October, weighed on the euro. Market participants expected the budget deficit to rise strongly under the next US government. The prospect that the United States could impose additional tariffs on euro area products also put pressure on the euro, as a reduction in US imports due to tariffs would diminish demand for the euro. As this report went to press, the euro was at its lowest level so far this year at US$1.05, down 1.6 % compared with the end of the second quarter of 2024.

The euro has lost ground against the pound sterling since the end of the second quarter of 2024. After the euro-pound sterling exchange rate had fluctuated only minimally in July, the single currency appreciated at the beginning of August following a policy rate cut by the Bank of England that surprised a number of market participants. Unlike the Eurosystem, however, the Bank of England left its monetary policy stance unchanged at its September meeting. The resulting increase in the short-term interest rate differential between the United Kingdom and the euro area led to small but steady losses for the euro. These came to a temporary halt when, at the end of October, the new UK government announced higher levels of new borrowing for the coming years. 1 Most recently, the euro stood at £0.83, down by 1.7 % since the end of June 2024.

The euro has depreciated against the yen on balance since the end of June 2024, amid sharp exchange rate movements. The euro reached a record high of ¥175 on 11 July, but, like other major currencies, then weakened rapidly against the yen up until the beginning of August. This shift was triggered by the Bank of Japan, which – in contrast to other major central banks – increased the degree of monetary policy restriction. The massive gains by the yen weighed on the profitability of currency carry trades, the unwinding of which further intensified the upward pressure on the yen. In addition, a number of indicators were published pointing to the surprisingly strong state of the Japanese economy. The euro reached just under ¥156 in mid-September, the weakest rate seen since the end of last year. It has since appreciated against the yen again, though, partly due to the fact that euro area monetary policy remained more restrictive than that of Japan. In addition, the long-standing governing party suffered surprising losses at the end of October in an election for the lower house of the Japanese parliament. The resulting political uncertainty drove the yen down further. Nevertheless, owing to the aforementioned sharp depreciation in July 2024, the euro has has been down 4.5 % overall since the beginning of the second half of the year, standing at ¥164 most recently.

On a weighted average against the currencies of 18 trading partners, the euro has depreciated compared with end-June 2024. The effective exchange rate of the euro against 18 trading partners has recorded losses on balance since the beginning of the second half of the year (-1.1 %). In addition to the euro’s depreciation against the US dollar, the pound sterling and the yen described above, the currency also lost ground against the Swiss franc (-2.8 %) and the renminbi (-1.9 %), amongst others. Nonetheless, price competitiveness in Germany and the euro area has deteriorated since last year. This marks a continuation of the deterioration from the previous year. Germany’s price competitiveness position is currently considered neutral based on the productivity approach. This follows the period from 2015 to 2023, where it could be regarded as having been favourable. Meanwhile, the price competitiveness of the euro area as a whole is still favourable, despite the recent deterioration.

Government bond yields in the United States initially declined amid expectations of interest rate cuts, but recently rose significantly in view of uncertainty and the looming budget deficit ahead of the US presidential election. Given the above-mentioned progress made in the disinflation process, the Federal Reserve initiated the interest rate reversal and lowered its federal funds rate by 50 basis points in September and by 25 basis points in November. Yields on US Treasuries initially fell significantly as a result. Against the backdrop of the US presidential election, however, market participants also increasingly turned their attention to the higher US budget deficits expected under the new US government. When viewed in isolation, the associated burden on the capital market and the heightened uncertainty exerted upward pressure on long-term yields. In addition, rising market-based inflation expectations at the end of the reporting period dampened expectations of rapid policy rate cuts in the United States. On balance, nominal yields on ten-year US Treasuries rose marginally by 4 basis points and stood at 4.5 % most recently.

Amid falling key interest rate expectations and a weaker-than-anticipated economic outlook, government bond yields in the euro area declined. The Governing Council further loosened its monetary policy and lowered key interest rates at its September and October meetings by 25 basis points respectively. Market participants’ expectations as to the short and medium-term path of key interest rates in the euro area also dipped significantly. For example, calculated on the basis of money market rates, the expected deposit facility rate for the period up to mid-2025 most recently stood at 1.8 %, which is around 150 basis points lower than its current level. This reflected the market’s assessment that the disinflation process is progressing apace in the euro area, too. According to survey findings, market participants deem monetary policy to be neither restrictive nor expansionary if key interest rates are roughly around the 2 % mark. 2 In addition, some surprisingly weak economic indicators, especially in Germany, revealed the economic outlook in the euro area to have unexpectedly worsened. This, too, weighed on yields. Towards the end of the period under review, interest rate increases from the United States rubbed off somewhat on euro area yields. Overall, however, monetary policy impulses prevailed, such that the GDP-weighted yield on ten-year euro area bonds fell by 29 basis points to 2.9 %.

Yields on ten-year Bunds fell less sharply than euro area bond yields on account of rising term premia. Using term structure models, ten-year yield can be broken down into an expected monetary policy path and a term premium that investors charge for taking on interest rate risk. Over the course of the reporting period, the impact of falling key interest rates on long-term yields was dampened by unusually sharp increases in term premia. Premia are rising partly due to the US factors referred to above. As far as Bunds are concerned, however, another important factor has been the gradual phasing out of monetary policy asset purchase programmes, which has seen the free float of Bunds held by private investors increase and the scarcity of Bunds reduce. 3 This means that scarcity premia, which appear in the model decompositions mentioned above as climbing term premia, are priced out. Since the beginning of September, investors’ appetite for risk has also risen considerably again. Rising risk appetite means less demand for default-free Federal securities, which makes yields on them go up.

Euro area government bond spreads narrowed further as key interest rates fell and risk appetite increased. The GDP-weighted yield spreads of ten-year sovereign bonds issued in the euro area over ten-year Bunds tightened by 17 basis points. One reason for this was the less restrictive monetary policy stance on both sides of the Atlantic, which had a positive impact on investors’ appetite for risk. The spread on ten-year French government bonds over Bunds exhibited a less significant decline due to persistently high uncertainty surrounding French fiscal policy and the evolution of the public deficit.

Yields on UK government bonds rose amid persistent domestic price pressures and heightened uncertainty regarding the fiscal outlook, while Japanese bond yields remained unchanged despite the market turmoil of the summer. After holding interest rates at the same level for a year, the Bank of England cut its policy rate by 25 basis points in August and again in November. As in the United States and the euro area, the medium-term policy rate expectations of market participants in the United Kingdom nudged up again in September. The presentation of plans envisaging high budget deficits in the United Kingdom going forward has recently led to additional upward pressure on yields on ten-year UK gilts, which rose by a total of 31 basis points to 4.5 %. In Japan, by contrast, yields on ten-year government bonds remained unchanged at 1.1 %. The Bank of Japan tightened its monetary policy in July, which came as a surprise. In August, Japanese yields fell in the wake of a bout of market turmoil, as the Bank of Japan tamped down expectations of further monetary policy tightening.

Market-based inflation indicators declined slightly over the period under review. For 2025, market-based inflation expectations calculated on the basis of euro area inflation swaps stood around 2.0 % at last count, placing them in line with the price stability objective. Across most of the reporting period, the assessment of euro area HICP inflation for 2025 was shaped by falling oil prices. The fall in oil prices saw market-based inflation indicators in annual terms move in the same direction on account of a base effect. In addition, the weaker-than-expected sentiment indicators for economic developments drove market participants to factor in higher downside risks with regard to the short and medium-term inflation outlook when making investment decisions. Most recently market and survey data have shown significant convergence to the Eurosystem’s projections, with market participants having been taken by surprise by the high inflation figures in October. The option-implied probability of average euro area inflation lying between 1.5 % and 2.5 % over the next five years stood at just under 50 % at last reckoning, the highest it has been since the outbreak of Russia’s war of aggression against Ukraine in early 2022. Overall, this is further indication that market participants assume that euro area inflation will now swiftly return to the Eurosystem’s target.

The increased confidence in the prospect of a sustained return to target-level inflation was also reflected in long-term surveys and market prices. For example, the five-year forward inflation rate five years ahead was in line with the target at 2.1 %, 0.2 percentage point below its mid-year level. Longer-term survey-based inflation expectations calculated on a quarterly basis by Consensus Economics for the euro area also remained at the 2 % target mark in October.

Yields on European corporate bonds fell as market participants’ appetite for risk grew. Yields on BBB-rated corporate bonds with residual maturities of between seven and ten years declined significantly, for both financial and non-financial corporations. With yields on matched-maturity Federal securities falling less sharply, yield spreads narrowed. Yield spreads on high-yield bonds also recorded comparably strong declines, a development which also manifested in lower credit default premia for all relevant bond classes. Overall, the financing costs of European firms, as measured by yield spreads, were recently below their respective five-year averages irrespective of their credit quality ratings.

Following a major price correction at the beginning of August, international equity indices rebounded significantly and managed to recoup some of the losses that had been incurred. The US S&P 500 index has gone up a further 8.9 % since the end of June, reaching a new peak. By contrast, the EURO STOXX hardly changed. Equity prices in the United States were bolstered primarily by the improved economic outlook and a positive start to the reporting season, which was also reflected in higher earnings expectations for US firms. US equities rose again significantly on the heels of the US elections. This was partly due to the fact that – as often happens after US presidential elections – uncertainty about the future policy stance of the United States abated. Taken in isolation, this acted as a boost to prices. The fact market participants were expecting profits of listed companies – especially financial corporations – to increase under the new US administration also played a role. The new US government plans to deregulate, raise tariffs and cut taxes. In the euro area, by contrast, earnings expectations fell in the period under review. Along with weaker economic activity, expectations of higher tariffs worldwide clouded the outlook. Conversely, lower interest rates and a greater risk appetite on the part of investors served to buoy up price developments when considered by themselves. Although the CDAX hit new record highs during the period under review (4.8 %), returns on German non-financial stock corporations are lower than European and US peers, even from a longer-term perspective (see the supplementary information). UK equities in the FTSE 100 index were down, by 1.1 %. Japanese equities clearly rallied in the summer after experiencing the sharpest stock market slump since October 1987 but still posted losses of 2.6 % over the period under review on balance (see the section on exchange rates).

Equities issued by banks in Europe and the United States have continued to significantly outperform the equity market as a whole. Since the end of June, these bank equities have recorded significant price gains. The prospect of higher interest margins owing to expectations of interest rate cuts receding somewhat of late, is likely to have contributed to the gains posted by bank equities. In the wake of the US presidential elections, US bank shares, in particular, were trading markedly higher again, boosted by expectations on the part of market participants that the new US administration could roll back at least some of the regulatory measures imposed on the financial industry following the financial crisis of 2008. Overall, the prices of European and US bank equities rose by a respective 5.9 % and 20.2 % on balance.

US equity valuations remain persistently high. Measured in terms of the earnings yield over the next 12 months, European and US equity valuations have risen. In the case of the EURO STOXX, the implied cost of equity – a metric which uses a dividend discount model to take account of the medium-term earnings expectations as well – was down, with both lower interest rates and a lower equity risk premium playing a part. This suggests that European equity valuations have gone up, though they remain moderate by long-term standards. The implied cost of equity for US equities barely changed, signalling that valuations persist at a historically high level.

Brandt, L., A. Saint Guilhem, M. Schröder and I. Van Robays (2021), What drives euro area financial market developments? The role of US spillovers and global risk, ECB Working Paper Series, No 2560.

European Central Bank (2024), The ECB Survey of Monetary Analysts, Aggregated Results, October 2024.

Deutsche Bundesbank (2024), Free float of government bonds in Germany and the rest of the euro area, Monthly Report, May 2024.