ECB Targets 2% Inflation as Medium-Term Goal

In 2024, the Eurozones inflation rate displayed a fluctuating trend. In September, the annual inflation rate dropped to 1.7%, marking a recent low. It rebounded to 2.0% in October and further increased to 2.2% in November. Rising service prices were the main driver, while a slowdown in energy price declines also contributed to inflation.

European Central Bank (ECB) President Christine Lagarde stated that the bank aims to reach its 2% inflation target by 2025:

“We have made significant progress in reducing inflation in 2024 and hope that 2025 will be the year we achieve our target as planned and expected under our strategy. Of course, we will continue working to ensure inflation remains stable at the 2% medium-term target.”

Balancing Inflation Targets and Responding to Dollar Depreciation

Amid global economic fluctuations and currency competition, the ECB faces complex policy decisions. On one hand, achieving the long-standing 2% inflation target requires monetary policy adjustments. On the other hand, the recent weakening of the US dollar has made the euro relatively stronger, undermining the competitiveness of European export products and threatening economic growth. To strike a favorable balance, the ECB has opted for interest rate cuts as a primary policy tool. This approach aims to lower the euros exchange rate, boost the international appeal of European products, and stimulate domestic economic activity.

While the latest Consumer Price Index (CPI) data is yet to be released, the Purchasing Managers‘ Index (PMI) provides clear insights into the current economic environment in Europe. Throughout 2024, the Eurozone PMI remained below the 50-point threshold, indicating contraction in overall economic activity. At the beginning of the year, the PMI hovered around 47, with slight improvement mid-year but failing to break above 50, reflecting persistent economic weakness. By the year’s end, the PMI dipped further to around 45, deepening concerns over the Eurozones economic slowdown. Weak performance in manufacturing and lackluster activity in the services sector dragged down the overall PMI, a trend closely linked to the global economic slowdown and insufficient regional demand.

The Indirect Impact of Rate Cuts on Exchange Rates

The indirect effects of rate cuts on exchange rates are also crucial. As the US dollar weakens, American export products have gained competitiveness in international markets, while Eurozone exporters face pressure due to the euros relative strength. By cutting rates to depreciate the euro, the ECB aims to enhance the price competitiveness of European exports and engage more effectively with the US in global trade.

However, this strategy is not without risks. Rate cuts can increase liquidity and inflate asset prices, potentially driving inflation higher and destabilizing financial markets. Consequently, while pursuing its inflation target, the ECB must carefully manage policy implementation to avoid long-term adverse effects on the economy.