German inflation remained steady in February, joining data from France and Italy to bolster expectations for a rate cut by the European Central Bank (ECB) next week. The newly-released flash estimate showed Germany’s headline inflation unchanged at 2.3% year-on-year, offering slight relief for the ECB. Core inflation dropped to 2.6% YoY from 2.9% YoY, while the broader European inflation measure stayed flat at 2.8% YoY.
Earlier today, retail sales and labor market data signaled that hopes for a consumption-led economic recovery may once again be thwarted. Retail sales grew by just 0.2% month-on-month in January, insufficient to counteract the weak final quarter of 2024. Meanwhile, the labor market showed only a very gradual improvement in February.
Headline Inflation Expected to Stay Between 2% and 2.5% This Year
Regional data points to several factors influencing inflation, such as favorable energy base effects and declining prices for alcohol, healthcare, and household goods, which helped contain inflation. However, food prices accelerated, and services inflation continued to ease gradually. Energy prices, which have been volatile due to geopolitical uncertainties, remain a key factor in determining inflation trends.
Moving forward, two opposing forces will shape underlying inflation: the cooling labor market, which could reduce wage-driven inflation, and the delayed effects of higher service costs. Additionally, rising selling-price expectations in industry, potentially worsened by upcoming European tariffs, pose another risk.
Given these dynamics, German headline inflation is expected to stabilize between 2% and 2.5% throughout the year, aligning with the ECB’s target of keeping inflation “close to but above 2%.”
ECB Rate Cut Likely Next Week Amid Eurozone Inflation Data
Today’s inflation data from Germany, France, and Italy has likely solidified the case for the ECB to cut rates by 25 basis points next week. The key question will be the ECB’s future approach. With the policy rate at 2.5%, it will be at the higher end of the neutral rate range. Some hawkish ECB members, such as Isabel Schnabel, have expressed reservations about further rate cuts. The crucial signal to watch next week is whether the ECB will modify its “restrictive” policy stance. Rather than dropping the term completely, a shift towards a “less restrictive” or “barely restrictive” stance might better reflect the current uncertainty.
Ultimately, given the eurozone’s structural weaknesses, impending tariffs, and cooling inflation pressures from the labor market, the ECB may need to reduce rates to at least 2% to ensure they are not restrictive and may even become accommodative.
WRITTEN BY MR KENDRICK
