After the European Central Bank cut interest rates today, markets are looking ahead to flash data on eurozone inflation, which will be released by Eurostat on Feb. 3.
Headline inflation is forecast to be 2.2% higher than January 2024 levels, according to FactSet consensus estimates, and down from December’s reading of 2.4% year on year.
Core inflation, which shows prices without energy and food costs, is expected at 2.7% year on year in January, the same level as December.
“Investors and central bankers will be pleased to read that the market expects eurozone inflation to fall to 2.2% in January, from December’s high of 2.4%. Either way, the belief that inflation is broadly under control was exemplified already in the European Central Bank’s 25 basis point rate cut today,” says Michael Field, chief equity market strategist for Europe at Morningstar.
“Core inflation is expected to remain stable at 2.7%. Although this figure stands well in excess of the central bank’s 2% target, core inflation has broadly been on a downward trend,” adds Field.
In December 2024, the greatest contributors to the annual euro area inflation rate (HICP) were services at +1.78 percentage points (pp), followed by food, alcohol & tobacco at +0.51 pp, non-energy industrial goods at +0.13 pp and energy at +0.01 pp.
Will Energy Inflation Affect January’s Data?
Goldman Sachs analysts, who expect that euro area core inflation will decrease to 2.7% year on year in January, expect “potentially stronger insurance price hikes and HICP weight changes posing an upside risk” to the bank’s core inflation forecast.
They also expect the “January effect” will be less pronounced this year compared to 2024. In financial markets, the “January effect” refers to the hypothesis that there is a seasonal increase in prices in the first month of the year.
After the recent increase in oil and gas prices, economists see energy inflation growing to 0.9% year on year from 0.1% in December. Spanish flash HICP inflation, released on Thursday, Jan. 30, showed upward pressure from fuel, and, to a lesser extent, electricity prices. These surprised on the upside rising 2.9% versus consensus estimates of 2.8%.
Goldman Sachs sees euro area headline HICP inflation at 2.57% year on year in December, up from 2.43% in December.
What to Expect from Eurozone Inflation in the Coming Months
Katharine Neiss, chief European economist at PGIM Fixed Income, said to Morningstar that “inflation outturns are expected to fluctuate around current levels at just above 2%, but to ultimately be on a clear trajectory to sustainably meet the inflation target.”
She also forecast that the first half of 2025 could see some volatility in inflation outturns that mask underlying trends, keeping inflation concerns alive. “For example, January data are affected by annual updates in the consumption basket weights, and the timing of Easter can affect March / April inflation data.”
Services inflation will stay on the radar in the coming months, because it provides a better gauge of domestically generated inflation. “At 4% in December, services price inflation remains elevated. We expect policymakers to pay close attention to the annual resetting of some services prices in January, and whether these are on a clear downward trend in the early months of this year. Of course, ongoing geopolitical uncertainty means that energy remains an upside risk, with recent rises pushing up on inflation, other things equal,” added Neiss.
What Will the ECB Do in its Upcoming Meetings?
“So far, the ECB’s moderately paced and methodical approach to cutting interest rates has been spot on,” said Field. “Expectations are for a further 75 basis points of cuts this year, which should be a significant tailwind for European equities in 2025. European equities currently trade at an attractive discount relative to their US and global peers.”
According to Neiss of PGIM Fixed Income, “the ECB remains on track to cut rates further in the coming months”, but in a gradual and limited way, taking the policy rate to 2% by year end.
“The ECB is about half way through its cutting cycle, having cut 100bps in 2024, with a further 100bps expected in 2025”. The risks to that outlook are to the downside. The ECB could do more cuts if the economy weakening should tip over to the labor market.
“All of this is in stark contrast to the US Federal Reserve Bank, where we think cuts are largely in the rear view mirror with the central bank on hold over the first half of this year. That view is underpinned by continued strength and resilience in the US economy, and the expectation of growth-friendly policies under the new US administration,” according to Neiss.
Martin Wolburg, senior economist at Generali Investments, sees the ECB’s year-end key rate at 1.75% after a series of 25 bps cuts. “In the months to come, lower wage growth and the petering out of base effects will push core inflation down,” he said. Moreover, he deems the consensus estimate of +1.0% and ECB staff projection at +1.1% growth in 2025 “too positive against our proprietary one (+0.8%) implying a more supportive policy stance.”
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