Eurozone Inflation Extends Decline At Start of 2024, But Core CPI Proves Sticky

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Eurozone annual inflation fell to 2.8% in January from 2.9% in December, which aligned with market expectations, the decline being driven by a sizeable -0.4% month-on-month reading.

Core inflation fell to 3.3% from 3.4%, but this was a surprise as consensus looked for a fall to 3.2%.

Markets took note: before this inflation print, investors were pricing 150bps of cuts in 2024; they are now pricing 140bps.

"The European Central Bank and its committee members will be firmly looking to readjust the market expectations of future rate cuts," says Pierre Roke, Associate at Validus Risk Management.

But the sharp decline in the month-on-month reading complicates matters, according to another analyst.

"Eurozone inflation down to 2.8%. But the big story is the -0.4% monthly reading," says Joshua Mahony, Chief Market Analyst at Scope Markets Ltd.

"The ECB want to make sure they are on track to reach the 2% target.... Well the 9-month annualised figure puts them on track to hit 1% headline CPI in just 3 months time," he explains.

For sure, the headline rate looks to be well on track to dip below 2.0%, but the complicating factor remains the core inflation reading, which creates something of a bind for the European Central Bank (ECB).

The ECB has made much about the need to watch core inflation and wages, and on this basis, policymakers are right to delay any rate cut.

Yet, headline inflation below the 2.0% target can't be ignored, creating a communication challenge going forward that could complicate the outlook for financial markets.

The market reckons the ECB is on course for an April rate cut, which explains the recent softness in the Euro.

But Validus Risk Management says the market is too complacent and will be disappointed as the ECB won't cut as soon, and by as much, as expected. Further 'pricing out' of rate cuts can help support the currency.

"After starting the year above 1.10 the Euro has gradually declined and settled between 1.08 and 1.09 throughout most of January, before dipping closer to 1.08 after last night’s hawkish FOMC meeting. On the back of this small re-adjustment of rate expectations, the Euro will likely again advance vs the Dollar closer to levels seen throughout January," says Roke.