Services-led slowdown takes headline inflation to 1.9% ahead of key central bank meeting
Eurozone inflation fell to 1.9% in May, dropping below the European Central Bank’s 2% target for the first time since September 2024 and fuelling market expectations of an interest rate cut later this week.
According to flash estimates released by Eurostat on Tuesday, annual consumer price inflation across the 20-nation bloc declined from 2.2% in April, surprising economists who had forecast a more modest dip to 2%. Core inflation—which excludes volatile food, energy, alcohol and tobacco prices—also eased, falling from 2.7% to 2.3%, led by a sharp deceleration in services inflation from 4.0% to 3.2%.
Jack Allen-Reynolds of Capital Economics said the drop confirmed that April’s services spike was likely a “blip” linked to Easter, and that the broader disinflationary trend remains intact.
Markets responded swiftly, with the euro falling 0.3% against the dollar and yields on German and French 10-year government bonds slipping. Traders are now pricing in a near-certainty of a 25-basis-point rate cut when the ECB meets on Thursday, which would lower the deposit facility rate to 2.0%.
Muted inflation backdrop supports easing bias
The ECB has already reduced rates seven times since June 2023, and economists broadly expect at least one further cut later this year. Riccardo Marcelli Fabiani of Oxford Economics said that “more easing should follow” after Thursday, citing muted wage growth, declining energy prices, and a subdued growth environment.
Some analysts, however, warn that the recent drop in inflation may not be sustained. Survey data suggest services inflation may rebound modestly, and structural pressures—including defence spending, deglobalisation, and ageing demographics—could add upward pressure over the medium term.
Bert Colijn of ING noted that May’s print raises the possibility of the ECB undershooting its target: “The strong drop in core and headline inflation serves as a clear sign that inflation could stay below 2% longer than expected.”
Divergent national trends and external uncertainty
Inflation remains uneven across the bloc. France saw the lowest annual inflation rate at just 0.6%, while Estonia recorded the highest at 4.6%. Several countries, including Spain, Belgium and the Netherlands, posted negative monthly inflation.
Meanwhile, the OECD maintained its euro area growth forecast at 1% for 2025 and reiterated its inflation forecast of 2.2%—highlighting the economic drag from trade friction. U.S. President Donald Trump’s proposed “reciprocal” tariffs are seen as a rising risk, with potential countermeasures from the EU likely to affect prices, though the timing and scale remain uncertain.
Amid this backdrop, the ECB faces a delicate balance. With rates now in “neutral” territory—neither stimulating nor restraining growth—some policymakers are urging caution, while others point to the risk of inflation expectations de-anchoring if the disinflationary trend continues.
Markets brace for ECB move
Investors broadly expect the ECB to announce a quarter-point cut on Thursday, marking a continuation of its policy pivot after nearly two years of tightening. A further reduction could follow later in 2025, though most pricing currently reflects a pause after this week’s move, with only a one-in-three chance of a second cut by year-end.
European equities slipped modestly on Tuesday, with the Euro STOXX 50 down 0.8%, as broader concerns about global growth—underscored by the OECD’s outlook revision—weighed on sentiment. Leading decliners included Orange, Société Générale and LVMH, while Deutsche Telekom outperformed with a 2% gain.
