Euro Zone Inflation Rises in December but ECB Rate Cuts Likely to Continue
Euro zone inflation edged up in December, marking a slight but expected increase that is unlikely to derail the European Central Bank's (ECB) trajectory of further interest rate cuts.
Inflation across the 20 euro-sharing nations climbed to 2.4% last month from 2.2% in November, according to Eurostat, matching the forecast of a Reuters poll of economists. The rise was attributed to higher energy prices and persistently elevated costs in the services sector.
Despite recent fluctuations around the ECB's 2% target, inflation is expected to trend downward, with the target likely to be achieved in the latter half of the year. The ECB, which reduced interest rates four times last year, remains committed to further easing, though the timing and pace of cuts remain under discussion.
Core Inflation Stays Sticky
Core inflation, which excludes volatile food and energy prices, held steady at 2.7%, while services inflation—the largest component of the consumer price index—ticked up slightly to 4% from 3.9%. These figures may prompt caution among policymakers as they consider unwinding restrictive measures.
Adding to concerns, an ECB consumer survey revealed that both short- and medium-term inflation expectations have risen. Inflation expectations three years ahead increased to 2.4%, up from the previous survey's 2.1%, remaining above the ECB's target.
Market Reactions and Rate Cut Expectations
The uptick in inflation was widely anticipated, particularly after similar trends in Spain and Germany. Markets still expect the ECB to lower rates at its January 30 meeting, though the likelihood of cuts at every meeting through June has diminished. Investors now assign a 50% probability that the ECB may skip a meeting in the first half of the year.
The ECB's deposit rate, currently at 3%, is projected to decline to 2% by year-end.
External Factors Influencing Prices
One factor complicating inflation dynamics is the recent strength of the U.S. dollar, which has driven up the cost of key imports, including energy. If the U.S. implements proposed trade tariffs, further increases in import prices could follow. However, such effects are likely to be treated as one-off events rather than triggers for policy shifts.
Economic Context
Even the ECB's hawkish members agree that inflation appears largely under control. The bloc faces weak economic growth, a softening labor market, and signs of slowing wage growth—factors that ease upward pressure on consumer prices.
Unemployment in the euro zone held steady at a record low of 6.3% in November, but hiring momentum has waned, with labor market studies suggesting gradual softening over recent months.
The ECB will need to balance these trends carefully as it continues its policy of gradual rate reductions in pursuit of long-term stability.