Eurozone December CPI slows to 2%, market expects ECB to remain on hold for an extended period.

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The inflation rate in the eurozone has fallen back to the 2% target level set by the European Central Bank, further solidifying policymakers’ key view: Unless there is a major change in the economic outlook, current interest rates will be maintained.

According to initial data released by Eurostat on Wednesday, the Consumer Price Index (CPI) in December rose by 2% year-on-year, down from the previous 2.1%, in line with economists’ expectations in a Reuters survey. Excluding volatile food and energy costs, core inflation slowed to 2.3% from 2.4% in November. Market-focused services inflation also fell from 3.5% to 3.4%.

After the data was released, the market reaction was relatively muted. The euro erased earlier losses against the dollar and held steady near 1.169, and the Stoxx 600 index showed no significant volatility.

Although inflation returning to target could provide a rationale for future rate cuts, traders only slightly increased their bets on monetary easing—pricing now shows the probability of about a 5 basis points rate cut by September this year, which is equivalent to about a 20% chance of another 25 basis points cut.

Price growth has hovered near the 2% target for more than half a year, allowing the European Central Bank to keep borrowing costs unchanged for four consecutive meetings since its last cut in June. The key deposit facility rate remains at 2%. Economists and investors generally expect that the central bank will make no further policy moves in the foreseeable future.

Inflation Divergence and Wage Pressure

While the overall inflation slowdown aligns with expectations, there are still notable differences in price growth rates within the eurozone. Data shows Spain’s inflation rate fell to 3%, Germany’s to 2%, and France’s slowed to 0.7%.

In terms of segments, services sector inflation remains a primary concern for the European Central Bank. Despite the slowdown in December, part of the reason was a drop in the volatile air ticket prices. Deeper pressure comes from wage growth. Data shows that the broadest measure of salary increases in Q3 stayed at 4%, a level still above what is considered consistent with price stability.

ECB President Christine Lagarde said last month that although wages had largely caught up after the surge in prices post-pandemic and are expected to moderate this year, the central bank still needs to “closely monitor related trends.” According to David Powell, senior eurozone economist at Bloomberg Economics, the December inflation slowdown is good news for the ECB but is mainly driven by energy costs and may be less related to monetary policy.

Policy Makers’ Stance and Market Outlook

Most policymakers believe inflation is under control, but remain cautious about the next steps given lingering global economic uncertainty. While Michael Field, chief equity strategist at Morningstar, commented that low and stable inflation might prompt the central bank to lean toward stimulus earlier, which is a positive signal for equities, mainstream institutions have not changed their judgement on the interest rate path.

Nordea analysts Anders Svendsen and Tuuli Koivu noted in a report: “We maintain the long-term view that the ECB will keep rates unchanged until 2026. The risk in the first half of the year leans toward a rate cut, while long-term risk leans toward a hike. This aligns with market pricing, and today's inflation data should not change this view.”

Long-Term Outlook and Potential Risks

At its last meeting of 2025, the ECB forecast that due to a slower pace of service cost moderation, this year’s inflation rate will only be slightly below the target level. According to the central bank’s baseline scenario, the average inflation rate in 2026 is expected to be 1.9%, dropping further afterward and then rebounding to 2% in 2028.

However, several external factors may cause inflation to deviate from the target. Potential risks include the yet-to-be-fully-felt impact of U.S. tariff policy, a strong euro, and the possibility of Germany implementing fiscal expansion policies. In addition, ECB senior officials told CNBC that the easing cycle is at or near its end, and the central bank will stick to its “meeting-by-meeting, data-dependent” decision-making approach.

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