May CPI Drops Below 2% as Core Inflation Slows – A Green Light for Further Rate Easing?

Euro area inflation data released on Tuesday revealed a notable deceleration in consumer prices, reinforcing expectations that the European Central Bank (ECB) may continue easing monetary policy in the coming months.

The Consumer Price Index (CPI) for May came in flat on a month-over-month basis (0.0%), while the annual headline CPI fell to 1.9%, down from 2.2% in April and meeting market expectations. This is the first time inflation in the eurozone has dropped below the ECB’s 2% target since 2021.

More importantly, Core CPI (YoY) — which strips out volatile components like food and energy — declined to 2.3%, a sharp drop from 2.7% last month. All three indicators aligned with consensus forecasts but mark a clear softening in price pressures.

A Turning Point in the Eurozone’s Inflation Cycle?

The decline of headline inflation to 1.9% YoY is not just symbolic. After peaking above 10% during the 2022 energy crisis, eurozone inflation has now returned to the ECB’s official target, a level not seen in over three years.

The zero growth in monthly prices suggests weakening short-term inflationary momentum. Falling energy prices, sluggish consumer demand in countries like Germany and Italy, and a stronger euro have all contributed to this moderation.

This marks a potential shift from a period of entrenched price instability to one where the ECB may gain more flexibility in monetary easing without risking an inflation resurgence.

Core Inflation Points to Structural Cooling

The decline in Core CPI to 2.3% is perhaps the most significant aspect of this report. Core inflation reflects underlying pressures in services and labor markets, and a drop of 0.4 percentage points in a single month is meaningful.

This suggests that not only are volatile sectors easing, but internal price dynamics—such as wages and rent inflation—are also beginning to lose steam. For ECB policymakers, this reinforces the case for continued easing without compromising price stability in the medium term.

Market Reaction: Bond Yields Drop, Euro Weakens, Equities Edge Higher

Markets responded swiftly to the data. German 10-year bund yields fell by around 5 basis points to 2.34%, as traders increased bets on further ECB rate cuts in Q3.

The euro declined by 0.3% against the U.S. dollar, breaking below the 1.07 threshold, amid growing expectations of diverging monetary paths between the ECB and the Federal Reserve.

Meanwhile, European equities edged higher, led by interest rate-sensitive sectors such as real estate and banking. The DAX and CAC 40 both gained modestly following the release, as investors welcomed the prospect of lower financing costs.

Global Comparison: Eurozone vs. U.S. and U.K.

Compared to other major economies, the eurozone now leads in its progress toward disinflation. In the U.S., headline CPI remains elevated at 3.3%, and core inflation sits at 3.4%, well above the Fed’s 2% target. Similarly, the U.K. has seen only limited disinflation, with core CPI still above 3%.

This contrast places the ECB in a relatively stronger position to proceed with a rate-cutting cycle. After already implementing its first cut in June 2025, this May report supports another cut by September, especially if inflation continues its downward trend through the summer.

Growth Headwinds Still Loom

While the inflation data offers relief, the eurozone economy remains under pressure. Germany, Europe’s largest economy, is flirting with technical recession. Spain and Italy are experiencing soft consumer demand, and unemployment has ticked up modestly in several southern member states.

Recent PMI surveys have shown a contraction in services activity in France and Belgium, highlighting broader concerns about weak domestic momentum.

This creates a complex policy environment where the ECB must balance supporting growth without reigniting inflation — a delicate trade-off given limited fiscal space in many eurozone countries.

Real Estate and Credit Markets Set to Benefit

Lower inflation and the prospect of additional rate cuts are already influencing housing and lending conditions. Mortgage rates in countries like Germany, the Netherlands, and Spain have started to decline, as banks anticipate a prolonged period of lower interest rates.

Consumer credit and business loans are also expected to become more accessible, potentially supporting a modest rebound in investment and household spending in H2 2025.

Policy Outlook: A Window for Continued Easing

May’s inflation data offers a clear signal that the ECB has room to continue gradual monetary easing. The year-on-year drop from over 5% inflation in early 2023 to below 2% today underscores the strength of the disinflationary trend.

More importantly, the synchronized drop in both headline and core inflation points to a broad-based cooling that extends beyond short-term volatility.

If this trend continues into June and July, the odds of at least two more rate cuts by year-end will increase, with markets already pricing in a 70% probability for the next cut by the September ECB meeting.

Eurozone Inflation – May 2025 Summary:

CPI (YoY): 1.9% (Expected: 1.9%, Previous: 2.2%)

CPI (MoM): 0.0% (Expected: 0.0%, Previous: 0.6%)

Core CPI (YoY): 2.3% (Expected: 2.3%, Previous: 2.7%)

Final Thoughts

This report underscores a pivotal shift in the eurozone’s inflation landscape. For the first time in over three years, the ECB can credibly argue that its inflation target is being met — and without triggering systemic risks to financial stability.

For investors, this opens the door to tactical opportunities in European bonds, rate-sensitive equities, and mortgage-backed assets. For policymakers, it offers a rare moment of breathing room to refocus on growth — without losing the inflation battle.