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Eurozone inflation slowed sharply in May, easing below the European Central Bank’s 2% target for the first time in over two years, bolstering expectations for additional interest rate cuts even as global trade tensions and structural challenges pose longer-term inflation risks.
Data from Eurostat on Tuesday showed consumer prices in the 20-nation currency bloc rose by just 1.9% year-on-year in May, down from 2.2% in April and below economists’ forecasts of 2.0%. Core inflation, which excludes volatile food and energy prices, fell more than expected to 2.3% from 2.7%, driven by a marked slowdown in services inflation, which eased to 3.2% from 4.0%.
This weaker-than-anticipated inflation reading reinforces market expectations that the ECB will cut interest rates at its meeting on Thursday. The bank has already lowered rates seven times since June 2024, as soft wage growth, easing energy prices, a firm euro, and sluggish economic expansion have collectively tamed price pressures.
“Given the clear disinflationary outlook, especially for services, the ECB cutting rates this Thursday seems an easy bet, and more easing should follow later in the year,” said Riccardo Marcelli Fabiani at Oxford Economics.
ING economist Bert Colijn echoed this view, noting, “A strong drop in core inflation in May to 2.3% and headline to 1.9% serves as a clear sign that undershooting the inflation target is still a possibility for the ECB.”
Diverging Pressures Complicate ECB Outlook
While the near-term inflation trend points towards continued disinflation, economists warn of significant long-term risks that could reignite price pressures. Factors such as trade wars, higher tariffs, supply chain realignment, and geopolitical instability are all seen as potential sources of future inflation. Additionally, demographic challenges from a shrinking working-age population, as well as defense and climate-related investments, may drive prices higher over time.
This mixed outlook has led investors to price in a likely rate cut on Thursday—bringing the ECB’s deposit rate to 2%—and potentially one more cut later this year. However, beyond that, markets expect the ECB to pause and reassess, with the probability of a third cut seen at roughly 30%.
ECB officials themselves are divided, with policy hawks cautioning against too much easing too soon, particularly given the risk of resurgent inflation from global supply chain disruptions and escalating geopolitical tensions.
Market Focus Shifts to ECB’s Next Steps
Despite the near-term inflation drop, the ECB’s medium-term strategy—typically looking one to two years ahead—means policymakers are unlikely to overreact to short-term data volatility. Nonetheless, the softening inflation backdrop strengthens the case for near-term easing, while leaving the door open for policy recalibration if global trade dynamics and other structural factors push inflation higher again.
For now, markets and analysts will closely watch the ECB’s policy signals on Thursday, as well as the bank’s updated economic forecasts, to gauge how it intends to balance the current disinflationary momentum with the potential for longer-term inflation risks.
