As January 30 approached, all eyes in the investment community turned towards the latest inflation data prior to the European Central Bank's (ECB) first meeting of the yearThis anticipation stemmed from the understanding that inflation levels could significantly influence the ECB's monetary policies.

On January 7, the European Statistics Office published preliminary statistics indicating that the eurozone's inflation rate rose to 2.4% year-on-year in December 2024, marking an increase for the third consecutive month and surpassing November's 2.2%. This was particularly noteworthy as it represented the highest inflation rate recorded in nearly five months.

Despite the inflation figures remaining above the ECB's target of 2%, market analysts generally believed that this would not hinder the ECB's plans to cut interest rates by 25 basis points at the end of January, with forecasts pointing to a gradual reduction of 100 basis points over the course of the year.

Following the data release, the euro experienced fluctuations against the dollar, initially dropping before slightly rebounding

By Tuesday, it had shown a modest increase of 0.08%. Meanwhile, the 2-year German bond yield, which is highly sensitive to interest rate shifts, remained relatively stable, showing a daily increase of less than a basis pointAs market expectations for an interest rate cut persisted, the STOXX 600 index in Europe closed the day up by 0.32%.

But what was driving this resurgence in inflation? The initial statistics released by the European Statistics Office pointed to a year-on-year consumer price index (CPI) increase of 2.4% in the eurozone for December, with a month-on-month rise of 0.4%, aligning with economist forecasts.

The core inflation rate, which excludes volatile items such as food and energy, was steady at 2.7%, meeting expectationsHowever, the persistence of core inflation highlighted the ongoing challenges in bringing the base inflation rate back to the ECB's 2% target.

Within the major components of inflation, the services sector continued to lead with an inflation rate of 4%, slightly higher than November's 3.9%. Wang Wenhu, an analyst at Huayuan Futures Research Institute, commented that while year-on-year changes in the eurozone’s CPI did not vary greatly, there was a conspicuous month-on-month increase, transitioning from a decrease of 0.3% in November to a positive growth rate of 0.4% in December.

The primary culprits for the recent spike in inflation were identified as the energy and services sectors, with energy costs seeing their first uptick since July 2024. Wang pointed out that rising energy prices, particularly for natural gas, were significant drivers of the inflation rebound

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Current gas inventories in Europe are considerably lower than in the same period of the previous year, largely due to reduced imports from Russia, thereby intensifying the supply-demand imbalanceFurthermore, persistent high inflation in the services sector was evidenced by the latest unemployment rate for the eurozone in November being only 6.3%, a historical low that suggests a tightening job market, giving workers stronger bargaining power over wages.

This uneven battle against inflation was reflected in the various CPI reports released this week from member states such as Germany, France, and SpainThe data revealed significant disparities in how different countries were managing inflationWhile France and Italy’s inflation rates remained below the 2% policy target, Germany and Spain saw unmistakable rebounds, hitting 2.8% each.

The German Statistical Office reported a year-on-year rise in December's CPI of 2.8%, up from 2.4% in the previous month, and exceeding analysts' expectations of 2.6%. The main contributors to this acceleration were notable increases in energy and food prices.

Wang noted that Germany's inflation rebound was more pronounced compared to France's, primarily due to energy concerns

France relies heavily on nuclear power and maintains a stable electricity supply, whereas Germany’s energy mix is more dependent on renewable sources and external natural gas suppliesRecently, low solar power generation and a significant drop in wind energy output, along with soaring natural gas prices, have brought about greater volatility and impact on the German economy.

Concerning the rising food prices, Zhao Yongsheng, Director of the French Economy Research Center at the University of International Business and Economics, explained that this surge was seasonal in natureTypically, during the end of the year and the beginning of the new year, fueled by festive shopping, European citizens tend to purchase more food items, which naturally drives prices upward.

Despite the inflation uptick in the eurozone, market sentiment remains largely confident that this will not deter the ECB from pursuing interest rate cuts later in January

However, following the announcement of higher-than-expected inflation rates in Germany and Spain, investor sentiment regarding a more aggressive cut of 50 basis points has diminished.

Bai Xue, a senior vice president at Dongfang Jincheng Research Development Department, stated that the core CPI's stability suggests overall inflation levels remain relatively manageableTherefore, the slight increase in December's inflation does not imply a robust rebound in inflationary pressure for the eurozoneThe overarching downward trend in inflation remains intactLooking ahead, we anticipate that with further economic slowdowns and cooling labor markets across the eurozone, inflation will likely continue on a downward trajectory.

Jack Allen-Reynolds, the deputy chief eurozone economist at Capital Economics, echoed these sentiments, noting that the stickiness of services inflation implies the ECB is likely to proceed with a cautious approach to interest rate cuts, even in light of an uncertain economic outlook.

ECB President Christine Lagarde stated last month that the direction of interest rate reduction was clear, particularly in light of proposed policies that may introduce protective barriers threatening already fragile growth prospects.

Bai also noted that the ECB's December meeting indicated a dovish stance, reflected in downward revisions to inflation projections for the next two years and economic growth expectations for the subsequent three years

Significantly, the phrasing indicating a “maintaining a sufficiently restrictive rate” was removed from the statement.

As a result, with limited pressures from inflation rebounds and significant economic downturn pressures, it is highly probable that the ECB will opt to continue interest rate cuts this month.

Looking towards 2025, in an environment still characterized by elevated economic downturn pressures, the trajectory of gradual interest rate cuts by the ECB may be clearer than that of the Federal ReserveBai emphasized that the current recovery basis in the eurozone remains unstable and that progress in cuts is essential for restoring domestic demandNonetheless, with services inflation demonstrating certain stickiness, decisions made by the ECB will likely continue to lean towards balancing growth risksThis suggests another likely series of 25 basis point cuts in meetings throughout the year, potentially accumulating to 100 basis points by 2025.

However, it is crucial to note the looming uncertainties posed by potential tariffs on trade, which represent a considerable threat to the ECB's forward strategies regarding interest rate cuts