As the year opens, attention turns towards monetary policy decisions in the Eurozone, particularly before the European Central Bank (ECB) meeting scheduled for January 30. Investors have been closely monitoring the latest inflation data, crucial for predicting potential adjustments in interest rates.

On January 7, the European statistics authority released preliminary figures indicating that the inflation rate in the Eurozone for December 2024 hit 2.4% year-on-year, marking a rise for the third consecutive monthThis increase is notable, as it surpasses November's 2.2% and stands as the highest rate observed in recent five monthsAlthough this figure exceeds the ECB's target of 2%, the overarching thought in financial markets seems to favor an expected interest rate cut of 25 basis points at the end of January, alongside a gradual total reduction of 100 basis points throughout the year.

After the data release, the euro experienced a slight dip against the dollar, though it later rebounded, showing a marginal increase of 0.08% during the day

The yield on the sensitive two-year German government bonds remained stable, reflecting a minor increase of less than one basis pointThe inflation report did not alter the market's expectations for a rate decrease, resulting in a 0.32% rise in the pan-European STOXX 600 index.

However, some strategists from Mizuho and Bank of New York Mellon have made bold predictions, suggesting that the euro could fall to parity with the dollarSuch foreign exchange pressures may complicate the ECB's ability to enact significant rate drops, particularly in light of rising energy costs following diminished gas supplies from RussiaThese dynamics could cast shadows over the ECB's outlook on future rate cuts.

But what lies behind the resurgence of inflation? The fresh data shows that inflation in the Eurozone rose by 2.4% in December compared to the previous year, matching economists' forecasts

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The core inflation rate, which strips out volatile items such as food and energy, remained stable at 2.7%. This stickiness in core inflation underscores the ongoing struggle to bring fundamental inflation down to meet the ECB's target.

When analyzing the components of inflation, the services sector stands out with a rate of 4%, slightly up from November's 3.9%. While the year-on-year fluctuation in the December CPI was less pronounced, the month-on-month increase was evident, rebounding from a 0.3% drop in November to a positive 0.4% growth.

The recent upturn in inflation can be attributed primarily to escalating energy and service costsEnergy prices, which had been stable for a period, began rising once again in July 2024, driven significantly by increasing costs for natural gasCurrent European natural gas inventories are markedly lower than in 2024, combined with reduced imports from Russia, creating a tightening of supply that affects inflation

Additionally, the resilient service sector inflation is noteworthy; with a recorded unemployment rate of 6.3% in November, the labor market remains tight, giving workers stronger negotiating power over wages.

The confrontation with inflation is not uniform across the EurozoneThis week, a wave of CPI data from member countries including Germany, France, and Spain revealed noteworthy disparities in their inflation battlesFrance and Italy managed to keep their inflation rates below the 2% policy target, even slightly lower than expected, while Germany and Spain saw their rates noticeably surge to 2.8%.

Germany’s statistics body reported a December CPI adjustment at 2.8% year-on-year, up from the previous month’s 2.4% and exceeding analysts' predictions of 2.6%. The rise in energy and food prices predominantly drove this accelerationGermany's inflation rebound outpaces that of France, likely due to its reliance on renewable energy sources and external gas supplies, in contrast to France's more stable nuclear energy framework.

Food price hikes can largely be attributed to seasonal variations; towards the end and beginning of the year, festive effect prompts increased purchases of food items, thereby nudging prices higher.

Looking ahead, despite the rise in Eurozone inflation, market participants generally remain convinced that this will not deter the ECB from pushing the interest rate button downwards at the end of January

Nevertheless, with Germany and Spain's inflation rates both exceeding expectations, investor speculation regarding a larger rate cut of 50 basis points has significantly diminished.

Stability in the core CPI suggests that the overall inflation levels remain relatively controlledThus, the slight uptick in December does not indicate a resurgence of inflationary pressures across the Eurozone—rather, the general trend of decreasing inflation appears intactFuture prospects hint that as economic momentum in the Eurozone slows and the labor market cools, inflation is likely to continue its downward trajectory.

Jack Allen-Reynolds, Deputy Chief Eurozone Economist at Capital Economics, asserts that the persistence in service sector inflation suggests that the ECB is likely to proceed with gradual rate cuts, even as economic outlooks remain bleak.

Christine Lagarde, President of the ECB, indicated last month that the path towards lower rates is clearly defined, especially in light of proposed protectionist policies in the U.S

that threaten an already fragile growth outlook in Europe.

From the ECB's December meeting statement, the policy stance leans dovishly, highlighted by lowered inflation predictions for the upcoming years and a revision of economic growth forecasts, notably omitting the phrase regarding retaining "sufficiently restrictive rates."

In light of these factors, the combination of limited inflation rebound pressure and substantial economic downturn forces suggests that the ECB is likely poised for continued rate cuts this month.

Projecting into 2025, amidst high levels of economic downturn pressure, the ECB’s path to gradual rate reductions appears clearer relative to that of the Federal ReserveCurrently, the Eurozone's recovery foundation remains precarious; considering that interest rate reductions are essential for bolstering domestic demand, and a sticky service sector inflation outlook persists, it is anticipated that the ECB will continue its trend of gradual rate cuts in 25 basis point increments at each meeting, summing up to a total of around 100 basis points by 2025.

Notably, the specter of potential tariffs poses a significant uncertainty that could influence the ECB's approach to rate cuts