Positive Surprise Fuels Optimism in European Markets

Eurozone inflation fell in May to 1.9%—below the European Central Bank’s (ECB) official target—delivering a welcome surprise to financial markets. According to preliminary figures published today (Tuesday) by Eurostat, this marks a sharp drop from April’s 2.2% and beats earlier forecasts of 2%. This data points to a clear easing of price pressures after a prolonged period of inflation driven by supply disruptions, high energy costs, and geopolitical uncertainty. The unexpected decline strengthens expectations for further monetary easing and turns all attention to the ECB’s upcoming interest rate decision later this week.

A Global Trend, but Europe’s Move is Especially Significant

The decline in Eurozone inflation is part of a broader global trend: most developed economies are managing to bring inflation under control. However, the European figure stands out, as the continent has struggled with particularly high inflation over the past two years due to the war in Ukraine, energy price shocks, and supply chain disruptions. The ECB responded with an aggressive rate-hiking policy, raising its deposit rate to a peak of 4% at the height of the 2023 price crisis. Now, with headline inflation below 2%, the central bank has room to loosen policy—a scenario that seemed impossible just a year ago.

Headline and Core Inflation: Broad-Based Easing

The fall in headline inflation is accompanied by a steady decline in core inflation—which excludes volatile items like energy, food, alcohol, and tobacco—now down to 2.3% from 2.7% in April. This measure is closely watched by policymakers, as it gives a clearer picture of underlying price trends. Notably, the services sector, which had recently been a source of persistent inflation due to labor shortages and rising wages, also saw inflation drop to 3.2% from 4% last month. This broad-based moderation across sectors gives the ECB greater confidence to consider further rate cuts, with less risk of reigniting price spirals.

Interest Rate Expectations: Another Cut on the Horizon

According to market pricing, there is now about a 95% probability of a further 0.25 percentage point rate cut at Thursday’s ECB meeting. This would follow April’s rate cut, when the deposit rate was reduced from 2.5% to 2.25%, breaking a long streak of rate hikes. The current rate is far below last year’s peak, reflecting renewed confidence in Europe’s ability to manage price pressures. Still, ECB officials are signaling caution, given mounting risks on the global stage.

Geopolitics and Trade Policy: New Uncertainties on the Horizon

Alongside lower inflation and prospects for more rate cuts, European markets face fresh uncertainty—this time from the United States. The possible return of Donald Trump to the White House and his push for new tariffs on European goods (“reciprocal tariffs” policy) are sparking fears of renewed global trade tensions. While the immediate impact of these policies on inflation is unclear, concerns about harm to European exports and slower economic growth are already echoing among investors and policymakers. Any EU retaliation, such as counter-tariffs, could raise input costs, dampen sentiment, and risk reviving inflationary pressures.

OECD Forecasts: Conservative and Cautious

The latest OECD forecast released today made no major changes to its outlook for Eurozone growth in 2025, which remains at 1%—a modest rate that nonetheless shows some resilience given global volatility. The inflation forecast is unchanged at 2.2%, slightly above the ECB’s target but no longer alarming. Still, the OECD cautions that risks remain elevated: a possible U.S. slowdown, ongoing global trade disputes, and persistent weakness in European manufacturing and credit sectors all require careful policy management.

Looking Ahead: “Wait and See”—Cautious Optimism With Persistent Risks

Recent data allows Europe to breathe a sigh of relief, at least in the short term. The drop in both headline and core inflation provides strong tailwinds for markets and encourages investors, but several challenges remain: possible trade disruptions, political pressures, lingering weakness in the real economy, and the need to balance support for growth with inflation control. The ECB may choose a “wait and see” strategy—cutting rates now but pausing further moves to assess how external risks play out and whether the inflation slowdown proves durable.

Conclusion: A New Chapter for European Monetary Policy—But Caution Still Needed

In summary, the sharp decline in Eurozone inflation, along with signs of economic stabilization and easing pressures in the services sector, signals an end to the period of severe inflation and the beginning of a new era in monetary policy. Investors and policymakers can be cautiously optimistic, but they must continue to watch for emerging challenges—from U.S. trade policy to ongoing fragility in manufacturing and credit. The delicate balance between supporting growth and ensuring price stability will remain the ECB’s central task in the coming months.