Eurozone inflation has dipped to 1.7%, marking its lowest point since September 2024 and falling below the European Central Bank's (ECB) medium-term target. This development, while seemingly positive, is not without its complexities. For some economists, the drop in inflation isn't a cause for celebration. Joe Nellis, emeritus professor and economic adviser at MHA, highlights that the disinflationary trend is partly driven by lacklustre demand. "This is not necessarily a cause for celebration," Nellis said. "Weak economic growth over recent years has weighed on demand, helping push inflation lower."
The core inflation, which excludes volatile energy and food prices, has also eased further, dropping from 2.3% to 2.2% year-on-year. This is the lowest level since October 2021. However, the easing of energy prices has supported the slowdown, but core inflation remains more persistent. With inflation now close to target and growth subdued across much of the bloc, there is no case for further tightening, Nellis explained.
The ECB is set to hold interest rates unchanged at the first Governing Council meeting of the year on Thursday. Alexandre Strott, economist at Goldman Sachs, said the ECB’s first meeting of the year is likely to be uneventful. "The Governing Council is likely to leave rates and all other policy parameters on hold," he said, noting that incoming data remain broadly in line with staff projections and that policymakers continue to view the current stance as appropriate. ECB President Christine Lagarde is therefore expected to reiterate that policy is in a "good place" for a sixth consecutive meeting.
However, the market reaction to this data has been muted. The euro was steady around 1.18 against the dollar, while German Bund yields were little changed at 2.88%. Eurozone equities edged higher, with the Euro STOXX 50 up 0.3%.
The falling inflation reflects weak demand, and this is a point that could spark differing opinions. It's a complex issue that invites further discussion. What will the ECB do next? Will they move interest rates? The markets are divided, with some seeing a one-in-five chance of a cut before year-end. But here's where it gets controversial... The ECB's decision will depend on how they interpret the current economic landscape. Will they focus on the short-term benefits of lower inflation or the long-term risks of weak demand? This is the part most people miss... The answer lies in the balance between economic growth and price stability, a delicate tightrope walk that the ECB must navigate.
