Inflation Rebounds: ECB's Big Rate Cut Now Unlikely

According to data released by Germany's Federal Statistical Office on January 6, the consumer price index (CPI) for December rose by 2.6% year-on-year, surpassing the market forecast of 2.4%, and up from 2.2% in November. The data reveals that services saw the fastest price increases, rising by 4.1%, while food prices increased by 2%. However, energy prices contracted by 1.7%, although the decline was narrower, failing to offset the overall acceleration in inflation. The rise in energy and food prices remains the main driver behind the inflation surge.

Excluding volatile food and energy prices, core inflation slightly rose from 3% to 3.1%. Meanwhile, the Harmonized Index of Consumer Prices (HICP) for the EU showed a 2.9% increase, surpassing the expected 2.6%.

After the data was released, the euro remained relatively stable against the US dollar, currently trading at 1.0411. The yield on two-year German government bonds rose by 4 basis points to 2.2%. As a result, market expectations for a significant interest rate cut by the ECB have weakened.

The unexpected rebound in inflation in Germany suggests that the ECB may need to maintain a more cautious stance on rate cuts, particularly as factors such as rising public transport fares and higher carbon emission prices are expected to continue pushing inflation up, especially ahead of the upcoming snap elections. This election could expedite the end of Chancellor Olaf Scholzs tenure.

Germany's Bundesbank has forecast that inflation will decline from 2.5% in 2024 to 2.4% in 2025, before falling to the ECBs target level in 2026. However, despite a potential easing of inflation in the Eurozone in 2024, the rate is expected to remain elevated. ECB officials have stated that their target is to bring inflation back to 2% by the end of the year, but achieving this goal is increasingly challenging.