Inflation in the eurozone fell back to single digits in December, with data published Friday morning showing the core rate hitting 9.2 per cent after annualized price growth topped 10 per cent in the previous two months.

Until now Slower It is unlikely to be enough to convince the ECB to stop raising interest rates just yet, with markets continuing to price in a series of hikes by officials in Frankfurt over the course of 2023.

“The ECB is likely to stick to its hawkish rhetoric in the near term despite the large declines – and the potential for further sharp declines this year,” said Francesca Palmas, chief economist for Europe at research group Capital Economics.

Why isn’t a fall enough to convince the ECB to change course?

While lower fuel prices and government subsidies to help businesses and households out of soaring electricity bills cut headlines inflation rates, underlying price pressures remain strong.

Berlin paid most household gas bills for December, which economists at Commerzbank estimated was 1.2 percentage points lower than the harmonized rate of headline inflation. the average He fell to 9.6 percent, down from 11.3 percent in the previous month. But growth in the cost of services, an indicator of how far price pressures are likely to persist, accelerated in December.

In Spain, the core CPI inflation rate – which excludes food and energy price movements – rose in the year to December, although it fell sharper than expected in the headline coordinated rate to 5.6 per cent.

Although core inflation in the eurozone fell from a record 10.6 per cent in October to 10.1 per cent in November, core inflation – at 5 per cent – remained at an all-time high. He is expected to remain there in December.

“This year will mostly be about falling under the blanket of inflation and seeing exactly what drives it,” said Paul Hollingsworth, chief European economist at French bank BNP Paribas.

For the ECB to change course, rate-setters will want to see a significant decline in the base rate and other measures of long-term inflationary pressures, such as wage growth. They will also look for signs that government support for households and businesses struggling with higher energy prices is boosting demand.

Christine Lagarde said interview With the Croatian newspaper Jutarnji List: “We need to be careful of the internal causes [of inflation] What we are seeing, mainly related to fiscal measures and wage dynamics, is not consolidating inflation.”

What’s next for inflation in Europe?

More declines are expected in the coming months, after decreases energy prices since the beginning of the year. And the impact of the increase in energy costs last year in the aftermath of Russia’s invasion of Ukraine will soon slip through the index, lowering the headline number significantly.

Carsten Brzeski, head of macro research at Dutch bank ING, predicted that inflation in the eurozone could fall back to the ECB’s 2 percent target by the end of 2023.

If the recent declines in gas prices continue, the ECB will almost certainly have to lower its inflation forecasts for this year. The central bank said in December that prices would rise 6.3 percent over the course of 2023, based on the assumption that natural gas prices average €124 per megawatt-hour over the entire year.

But the price of the TTF benchmark European gas contract is down about 10 percent this week to 69.70 euros/MWh as of Thursday afternoon – a level 80 percent below the August high of 340 euros/MWh.

“The ECB’s inflation expectations are currently very high, just judging by the technical assumptions of gas and oil prices and where those prices are currently,” Brzeski said.

What does this view of interest rates mean?

Last year, the European Central Bank responded to soaring inflation by raising interest rates at an unprecedented pace, raising the deposit rate from 0.5 percent in July to 2 percent by the end of the year.

European Central Bank President Christine Lagarde said in December that markets were underestimating the magnitude of higher borrowing costs, adding: “We should expect a 50 basis point hike in interest rates for a while.”

Since then, investors have been seeking about 1.5 percentage points of price increases over the first three quarters of 2023.

The interest rate rose by half a point at officials’ next policy meetings in February and March, and some smaller moves later in the year remain the outlook, despite sharper-than-expected declines in inflation this week.

Without sharper declines in measures of underlying price pressures, it is unlikely that markets and economists’ expectations for interest rates in the eurozone will change significantly.

“Everything goes back well to an inflation rate of 3 or 4 percent,” Hollingsworth said. “But it may be difficult to get down to 2 percent, especially if there is a more moderate recession than expected.”

“We really need to see service prices and wage growth soften to convince the ECB that it has done enough,” he added.

Additional reporting by Valentina Romei