Eurozone inflation slows in December, but price pressure rising

Eurozone inflation fell last month, but underlying price pressure is still rising and economic growth indicators are surprisingly mild, suggesting that the European Central Bank (ECB) will keep raising interest rates for months to come.

Fighting a historic prices surge, the ECB has since July lifted borrowing costs at the fastest pace on record. It promised more moves this year to curb inflation that its economists expect to stay above its 2% target well into 2025.

Consumer price rises in the 19 countries using the euro slowed to 9.2% in December from November’s 10.1%, Eurostat data showed on Friday, well below a Reuters poll forecast of 9.7%, with the drop driven by lower energy prices.

The eurozone has since expanded to 20 nations, with Croatia joining on January 1. But the headline number masked a more malignant trend, with all key components of core inflation accelerating.

Excluding volatile food and energy prices, inflation picked up to 6.9% from 6.6%, while an even narrower measure that excludes alcohol and tobacco rose to 5.2% from 5%.

Services and nonenergy industrial goods inflation, both watched closely by the ECB to gauge the durability of price growth, accelerated, adding to concern that inflation is more stubborn than expected.

“Rising core inflation means that not much will sway the European Central Bank from the hawkish path it set out late last year,” said ING economist Bert Colijn.

Mild recession

Other indicators suggest that the bloc's winter recession will be milder than expected, leaving the ECB with more work to do to tame prices. A key economic sentiment indicator improved more than expected while retail sales data also showed surprising resilience.

Exceptionally mild weather, implying lower use of expensive energy, will help too, by propping up household spending power and preserving corporate margins. But that may complicate life for the ECB.

The recession was expected to push up unemployment and dampen price pressures. Employment, already at a record high, is going up, not down.

Fiscal support for households is more generous than hoped and this spending is adding to purchasing power, weighing against restrictive ECB policies.

“The delayed pass-through of high production costs and a still-strong labour market will sustain core inflation,” said Riccardo Marcelli Fabiani of Oxford Economics. With record high core inflation that is likely to remain high in  coming months, “we expect the ECB to deliver two 50 basis point hikes in February and March and pause afterwards amid easing inflation and subdued economic trends”, said Fabiani. 

Although inflation may rise again in January, the peak has probably passed and the ECB’s focus will start shifting to how quickly it will fall back.

Markets and surveys are beginning to factor in the possibility that price growth will stay longer above 2% and even ECB forecasts, which proved overly optimistic in the past two years, do not see the bank hitting its target until late 2025.

The problem is that the longer inflation stays high, the harder it will be to tame it as companies start adapting their pricing and wage policies, perpetuating price pressures.

That is why the ECB raised rates by a combined 2.5 percentage points last year — mirroring its global peers, even if somewhat later — and promised big hikes in February and March that are set to take the deposit rate to about 3%.

“We expect the deposit rate to be at 3.25% in the spring, where it is likely to remain for some time thereafter,” said Commerzbank’s Ralph Solveen.

Reuters