Eurozone June CPI falls to 2.8%: Urgency for rate hikes sharply reduced, ECB enters “data-dependent” neutral phase

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Eurozone inflation cooled faster than market expectations, further reducing the urgency for the ECB to continue raising rates.

On July 1, preliminary data released by Eurostat showed Eurozone CPI rose 2.8% year-on-year in June, lower than market expectations of 3.0% and a noticeable drop from May's 3.2%; core inflation, excluding food and energy, dropped from 2.6% to 2.4%, also below the market expectation of 2.5%. The data prompted rapid downward adjustment in money market bets on further tightening by the ECB this year.

Despite obvious improvement in inflation data, several ECB officials attending the annual ECB forum in Sintra, Portugal, did not rush to signal a policy shift, but instead emphasized that whether the energy price shock caused by the Middle East conflict has fully dissipated still needs to be observed, and further attention must be paid to the spillover of energy costs into food and service prices.

Inflation falls across the board, rate hike expectations ease

This inflation data is regarded as one of the most important economic indicators ahead of the ECB's July 23 policy meeting.

The data show that besides headline inflation, ECB's focus on service sector inflation also dropped from 3.5% in May to 3.2%, showing that price pressures from previous energy price increases have not spread as widely as markets feared.

Recently, international oil prices have fallen back to pre-conflict levels as the US-Iran ceasefire was extended and the Hormuz Strait reopened, becoming a key factor driving inflation down.

After the data release, markets further lowered expectations for the ECB to continue raising rates. Previously, investors generally expected the ECB to raise rates at least one more time by 25 basis points this year. After the latest inflation data, rate swap markets showed these expectations have cooled markedly.

Energy risks remain, ECB stays cautious

Though markets are reassessing the policy path, ECB officials generally believe it is too early to declare victory against inflation.

ECB Chief Economist Philip Lane said the main thing to watch now is whether the rise in energy costs over the past four months will continue to spill over into food and service prices. He said:

"We will continue to make decisions meeting by meeting and will not pre-commit to a future rate path."

Dutch central bank governor Olaf Sleijpen also said recent oil price declines are undoubtedly positive for controlling inflation, but it remains to be seen whether earlier rises still have 'lagged effects'.

German central bank governor Joachim Nagel was relatively hawkish, believing the energy price shock from the Middle East conflict 'has not truly left the system,' and inflation will stay above the ECB's 2% target for some time.

Belgian central bank governor Pierre Wunsch said that if future data shows it's necessary, the ECB may still raise rates further, but current market expectations for continued tightening have clearly declined compared to June.

Wages and second-round effects still affect September decisions

Some officials believe easing tensions in the Middle East have reduced the urgency for another rate hike soon, but new inflation risks have not fully disappeared.

Austrian central bank governor Martin Kocher said future policy choices for upcoming meetings will likely be between 'raising rates again' and 'keeping rates unchanged,' rather than discussing rate cuts. He noted that if wage negotiations push up salaries further this autumn, service sector inflation could be supported and price pressure persist.

Apollo Global Management Chief Economist Torsten Slok also believes that even though energy prices have clearly declined, the ECB may still keep the option to raise rates again in September, as decision-makers want to confirm there are no obvious second-round inflation effects.

ECB enters “data-driven” stage

In June, the ECB raised its deposit rate by 25 basis points to 2.25%—the first rate hike since 2023 and the first G7 central bank to tighten policy after the latest Mideast energy shock.

ECB President Lagarde recently stated June’s rate hike was not an “insurance hike,” but a necessary decision based on available data at the time. She emphasized that no subsequent data have overturned that judgement.

As inflation for June falls sharply and international oil prices stabilize, the policy environment facing the ECB is becoming more balanced. Markets are lowering bets on further rate hikes this year, but decision-makers still stick to the 'meeting by meeting' strategy, unwilling to pre-commit to future policy amid uncertainties in energy prices, wage growth, and service sector inflation.

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