Eurozone inflation has retreated to the European Central Bank's 2% target, a key data point that further solidifies policymakers' core view: unless there is a significant change in the economic outlook, current interest rate levels will be maintained. According to preliminary data released by Eurostat on Wednesday, the Consumer Price Index (CPI) rose 2% year-on-year in December, slightly lower than the previous 2.1% and matching the expectations of economists surveyed by Reuters. After excluding volatile food and energy costs, the core inflation rate slowed from 2.4% in November to 2.3%, while the closely watched services sector inflation rate also decreased from 3.5% to 3.4%. Market reaction following the data release was relatively muted. The euro erased its earlier losses against the dollar, trading flat near 1.169, while the Stoxx 600 index also showed no significant movement. Although the return of inflation to target could provide a rationale for future rate cuts, traders only slightly increased their bets on monetary easing. Pricing now indicates a roughly 20% probability of an additional 25-basis-point cut by September, equivalent to about a 5-basis-point increase in the likelihood of easing. Price growth has been hovering near the 2% target for over half a year, allowing the ECB to keep borrowing costs unchanged for four consecutive meetings since its last rate hike in June. The key deposit facility rate currently stands at 2%. Economists and investors widely expect no further policy moves from the central bank for the foreseeable future. While the overall slowdown in inflation met expectations, significant disparities in price growth rates persist within the Eurozone. Data shows Spain's inflation rate fell to 3%, Germany's dropped to 2%, while France's slowed to 0.7%. Within specific sectors, services inflation remains the ECB's primary concern. Although the December figure showed a decline, this was partly due to a drop in volatile airfare prices. Deeper underlying pressure stems from wage growth. Data indicates that the broadest measure of wage increases held steady at 4% in the third quarter, a level still considered higher than what is deemed consistent with price stability. ECB President Christine Lagarde stated last month that although wages have mostly caught up post-pandemic and are expected to moderate this year, the central bank still needs to "closely monitor the relevant trends." According to analysis by David Powell, Senior Eurozone Economist at Bloomberg Economics, the December inflation slowdown is good news for the ECB, but it is primarily driven by energy costs and may have little direct connection to monetary policy. Most policymakers believe inflation is under control but remain cautious about their next steps given lingering global economic uncertainties. While Morningstar's Chief Equity Strategist Michael Field commented that low and stable inflation might prompt the central bank to lean towards stimulus sooner, which would be positive for equity markets, mainstream institutions have not altered their outlook on the interest rate path. Nordea analysts Anders Svendsen and Tuuli Koivu noted in a report: "We maintain our long-held view that the ECB will keep rates on hold throughout 2026. Risks in the first half lean towards a rate cut, while longer-term risks lean towards a hike. This is consistent with market pricing, and today's inflation data should not change this view." At its final 2025 meeting, the ECB projected that inflation would only dip slightly below target this year, influenced by a slower-than-expected moderation in services costs. Under the central bank's baseline scenario, average inflation is forecast at 1.9% in 2026, declining further thereafter before rising back to 2% in 2028. However, several external factors could still cause inflation to deviate from the target. Potential risks include the yet-to-be-fully-felt impact of US tariff policies, a strong euro, and possible fiscal expansion in Germany. Furthermore, senior ECB officials disclosed to CNBC that the easing cycle is near or at its end, and the central bank will continue to adhere to its meeting-by-meeting, data-dependent approach to decision-making.
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