European Central Bank Policy and the Outlook for Eurozone Bonds

The European Central Bank's (ECB) September 2025 decision to maintain key interest rates at 2.00% for the deposit facility, 2.15% for the main refinancing operations, and 2.40% for the marginal lending facilityMonetary policy decisions - European Central Bank^[1] has sparked renewed debate about the sustainability of bearish rate expectations in the Eurozone bond market. While the ECB's staff projections suggest headline inflation will average 2.1% in 2025 and core inflation 2.4%Monetary policy decisions - European Central Bank^[1], the divergent economic signals from Germany and France complicate the narrative. This analysis examines whether the current bearish outlook—rooted in expectations of rate cuts—remains viable in light of evolving PMI data and the ECB's data-dependent policy stance.

Germany: A Tale of Two Sectors

Germany's September 2025 HCOB flash composite PMI rose to 52.4, the fastest growth in 16 monthsGerman business activity grows at accelerated clip in September^[3], driven by a services sector rebound to 52.5 from 49.3 in AugustMonetary policy decisions - European Central Bank^[1]. This suggests resilience in consumption and business activity, bolstered by a recovering labor market. However, the manufacturing sector remains a drag, with its PMI dropping to 48.5—a four-month lowECB can still frustrate euro surge with 'contingency cut'^[2]. Inflationary pressures are also intensifying, particularly in services, where input and output charges rose at their fastest rates in monthsMonetary policy decisions - European Central Bank^[1].

This duality presents a challenge for the ECB. While services-driven growth supports the case for accommodative policy, manufacturing weakness and inflationary pressures could delay rate cuts. According to a report by Reuters, the ECB's cautious approach reflects concerns about global trade tensions, including U.S. tariffs, which could disrupt Germany's export-dependent economyECB can still frustrate euro surge with 'contingency cut'^[2].

France: A Contractionary Headwind

In contrast, France's September 2025 composite PMI fell to 48.4, the fastest contraction since AprilGerman business activity grows at accelerated clip in September^[3], with both manufacturing and services sectors reporting declining output. New orders have shrunk for 16 consecutive months, attributed to weak domestic demand and political uncertaintyGerman business activity grows at accelerated clip in September^[3]. This contractionary trend poses a risk to the ECB's inflation target, as reduced activity could lead to downward price pressures.

The ECB's staff projections, which assume 1.2% Eurozone growth in 2025Monetary policy decisions - European Central Bank^[1], may need recalibration if France's slump persists. A report by InvestingLive notes that France's fiscal outlook is increasingly fragile, with public debt rising and private-sector investment waningFrench and German PMI data reaffirms ECB policy stance on pausing^[4]. Such developments could force the ECB to prioritize growth support over inflation control, potentially opening the door to rate cuts.

ECB Policy: Data-Dependent and Guarded

The ECB's September 2025 policy statement emphasized a “meeting-by-meeting” approachMonetary policy decisions - European Central Bank^[1], with no pre-committed path for rate cuts. While the central bank left the door open to a “contingency cut” in response to unforeseen risksECB can still frustrate euro surge with 'contingency cut'^[2], its current inflation outlook—aligned with the 2% target—suggests no immediate urgency. The ECB's upward revision of 2025 growth to 1.2%Monetary policy decisions - European Central Bank^[1] further reinforces its patience, as stronger-than-expected economic resilience reduces the need for aggressive easing.

However, the divergent PMI trends between Germany and France highlight the ECB's balancing act. A Reuters analysis underscores that the central bank is monitoring “downside risks to growth”ECB can still frustrate euro surge with 'contingency cut'^[2], particularly in France, while also watching inflationary pressures in Germany's services sectorMonetary policy decisions - European Central Bank^[1]. This duality complicates the sustainability of bearish rate expectations, as the ECB may delay cuts until a clearer consensus emerges on inflation and growth trajectories.

Implications for Eurozone Bonds

The bearish rate expectations currently priced into Eurozone bonds—reflected in the 99% probability of a rate hold in SeptemberECB can still frustrate euro surge with 'contingency cut'^[2]—may be premature. While the ECB's forward guidance lacks specificity, its recent actions suggest a preference for stability over rapid easing. For bond investors, this implies that yields may remain range-bound in the near term, with limited upside potential until Q4 2025.

However, a “contingency cut” in late 2025 cannot be ruled out if France's contraction deepens or global trade tensions escalateECB can still frustrate euro surge with 'contingency cut'^[2]. In such a scenario, Eurozone bonds could see a yield decline, particularly in Germany, where services-driven growth might soften the ECB's stance. Conversely, a prolonged French slump could force the ECB to prioritize growth, creating asymmetric risks for bond markets.

Conclusion

The sustainability of bearish rate expectations in the Eurozone bond market hinges on the ECB's ability to navigate divergent economic signals. Germany's services rebound and France's contractionary trends create a policy dilemma: address inflationary pressures or support growth. While the ECB's data-dependent approach and revised growth forecasts suggest rate cuts are not imminent, the risk of a contingency cut remains. Investors should monitor October and December 2025 policy meetings closely, as these will likely determine whether the current bearish outlook holds or is recalibrated in response to evolving economic conditions.