06:10 AM EST, 03/06/2025 (MT Newswires) -- Germany's new government said it will loosen fiscal rules and deploy 900 billion euros in fiscal spending, setting off a seismic shift in European markets, said ING.

Wednesday's 40bps selloff in German Bunds was largely matched by other European Union sovereigns on the view that deficits will increase, inflation may rise and growth can improve, wrote the bank in a note. The ING rates team's impression is that those moves shouldn't be reversed, even if the bank could see some adjustments in the coming days following the oversized move. Beyond that, the risks are probably skewed to the 3% handle in 10-year Bunds.

The implications for the euro are "enormous," stated ING. EUR/USD is trading at 1.08 and follows a more than 3% rally in the past two sessions.

Interestingly, that level is embedding a relatively contained amount of risk premium, or in other words, short-term valuation: around 1.2% in ING's calculations. That is because the key rates-foreign exchange transmission channel -- the two-year swap rate differential -- has tightened significantly too. That means markets are repricing the European Central Bank curve higher while repricing the United States Federal Reserve curve lower -- a dramatic and highly unusual divergence.

The EUR:USD two-year swap rate gap is at -145bps while it was -175bps a week ago and -- along with the move in equities and other parts of the yield curve -- now returns a short-term fair value for EUR/USD at 1.067.

With these considerations in mind, the bank is reluctant to call for the peak in EUR/USD just yet. Crucially, Markets have two key events before the end of the week: the ECB meeting later Thursday and U.S. payrolls on Friday.

The ECB's widely-expected decision to cut rates by 25bps on Thursday shouldn't be influenced by recent market swings, pointed out ING. The communication in the statement and during the press conference will, however take both fiscal and market developments into greater account.

The main question on Thursday is whether the ECB lifts the reference to monetary policy being "restrictive" after taking rates to 2.5%, ING said. The bank originally thought it wouldn't, but the notion that fiscal spending is finally coming through -- and that the risks to inflation are shifting higher as a consequence -- could be giving Governing Council hawks some stronger backing. The repricing in the ECB curve has largely happened already, but President Christine Lagarde can still give an extra boost to the euro should she signal a more cautious tone on further cuts.

An extension to 1.10 in the rally would be inconsistent with the prospect of U.S. tariffs on the EU and rate differentials, and ING's model still shows at least a 1%-1.5% correction is in store for EUR/USD in the short term. For Thursday and Friday, volatility and major risk events argue against actively picking the peak in EUR/USD.

Sweden reported stronger-than-expected inflation figures for February earlier on Thursday. CPIF accelerated more than consensus from 2.2% year over year to 2.9%, with the core measure rising to 3.0% against a 2.7% consensus.

The data reinforces the view that the Riksbank may stay on pause at the next meeting and helped EUR/SEK move deeper below 11.00 after breaking crucial resistance overnight, added ING. This move is in line with the bank's expectations.

ING predicts EUR/SEK to trade only temporarily below 11.0 as its model now shows almost 3% undervaluation -- an indication that a lot of the positives are in the krona's (SEK) price.

The bank's forecast for the remainder of the year still has EUR/SEK above 11.00 -- mostly in the 11.0-11.30 range -- as ING expects U.S. tariffs to temper with the strong European sentiment to which SEK has a higher beta than the euro itself, and there is also a possibility of some geopolitical risk being priced back in after a largely expected Ukraine-Russia peace deal.

The central bank of Turkey (CBT) will cut rates again by 250bp to 42.50% later Thursday, in line with market expectations, according to ING. Monday's inflation confirmed the disinflationary trend with some downside surprise in February.

Overall, both food and non-food groups were drivers of the lower-than-expected inflation after a large upside surprise in January. The downtrend in annual inflation has also continued. In a move aligning with disinflation efforts, the ministry of treasury and finance reversed the hospital copayment hike, contributing to a benign reading last month.

While there are pricing pressures due to the recovery in domestic demand, leading producers to pass cost increases to consumers, disinflation is expected to continue as the CBT has signaled it will maintain its tight stance despite the start of interest rate cuts, ongoing real lira (TRY) appreciation, and improvement in services inflation, noted the bank.

ING estimates inflation to fall below 30% by the end of 2025. This backdrop is supportive for the CBT to continue with rate cuts, ending this year with 29.0% in the bank's forecast.

TRY continues to trend real appreciation and provides a fat carry despite the start of the CBT cutting cycle last December. Despite further rate cuts this year, TRY remains ING's favorite carry trade in the emerging markets space. The bank expects USD/TRY to reach 38.10 by mid-year and 40.20 by the end of this year.