Inflation in the eurozone accelerated in December, highlighting the challenge of reaching the 2% target set by the European Central Bank as governments withdraw support for high energy costs. The CPI increased by 2.9% year-on-year, up from 2.4% in November. The overall picture is that underlying inflation is easing, and overall inflation is likely to be lower than the ECB’s December forecasts. However, the central bank will be more cautious of declaring victory over inflation than the Fed.

Nevertheless, investors are betting that the ECB will lower interest rates before mid-2024. Money markets are now anticipating a 145-basis-point monetary policy easing by the end of 2024, down from nearly 175 basis points last week. The ECB finds itself in a similar situation to the Fed, needing to temper what appears to be exuberant and dangerous optimism.

A member of the ECB’s Executive Board, Isabelle Schnabel, stated at the end of December, “We currently expect that inflation could pick up temporarily in the short term,” adding, “We still have some way to go, and we will see how difficult the famous ‘last mile’ will be.”
Eurozone data follows a series of national reports revealing divergences among the bloc’s largest economies. While inflation soared in Germany, it accelerated more moderately in France, held steady in Spain, and slowed down in Italy.

However, the economic situation is very different from the American one. The economy is sluggish and could help the ECB to ease price pressures. Weighed by high borrowing costs, weak global demand, and geopolitical issues, eurozone production likely declined in the fourth quarter after a similar contraction in the previous three months. Indeed, labour market resilience fuels concerns that price growth may persist.

Nonetheless, the European Central Bank should provide the markets with a clear path regarding monetary policy and balance sheet reduction. Without that, it will give the impression of navigating without a compass, stuck between hawks in the north and doves in the south. Worse, it may be forced to follow the policy set by the Fed to prevent the euro from being affected by movements in the dollar.