Eurozone inflation rose in December, a setback that was expected but unlikely to change the European Central Bank’s course toward further interest rate cuts.
According to Eurostat, inflation in the 20 countries sharing the euro increased to 2.4% in December, up from 2.2% in November. This increase, driven by higher energy costs and persistently high services prices, was in line with economists’ expectations based on a Reuters poll. Inflation in recent months has remained just above the ECB’s 2% target, with fluctuations expected to continue in the short term. However, the overall trend is expected to decline, and the ECB’s target is likely to be met in the latter half of the year.
The ECB had already reduced interest rates four times last year and signaled that its inflation target is within reach. As such, further policy easing is expected, although the pace and timing of any future cuts remain uncertain.
Underlying inflation, which excludes volatile food and energy prices, held steady at 2.7%, while the services sector, the largest contributor to consumer prices, saw an increase from 3.9% to 4%. This persistence in underlying inflation could prompt the ECB to adopt a more cautious approach in loosening monetary policy in the coming months.
Additionally, a survey from the ECB revealed rising inflation expectations, with three-year ahead expectations climbing to 2.4%, up from 2.1% in the previous survey. This reflects concern that inflationary pressures may persist longer than anticipated, despite the overall downward trend in inflation.
While December’s inflation spike was expected following data from Spain and Germany, markets are still pricing in further rate cuts from the ECB. A reduction in rates is expected at the ECB’s next meeting on January 30, but there is now a 50% chance that the ECB could skip a meeting at some point in the first half of the year. The deposit rate, currently at 3%, is projected to fall to 2% by the end of 2025.
One factor contributing to the more cautious market outlook is the recent strength of the U.S. dollar, which is making imports of key commodities, including energy and car fuel, more expensive. However, market analysts suggest that any impact from U.S. trade tariffs under the new administration is likely to be short-term and not warrant policy adjustments.
Despite these challenges, even the most hawkish members of the ECB’s Governing Council appear to agree that inflation is largely under control. Economic growth remains weak, the labor market is softening, and recent wage agreements point to a significant slowdown in income growth, which is a major driver of inflationary pressures. Unemployment in the eurozone remained at an all-time low of 6.3% in November, although hiring activity has slowed.
