Euro Area inflation expectations have risen sharply over the past several months. That change is forcing analysts to reconsider plans for early rate cuts from the European Central Bank (ECB). Contra that backdrop of persistently low inflation, we believe the ECB is entering a new and complicated paradigm. The hype around September’s inflation data almost guarantees that it will be a non-event, yielding little in the way of help to project future monetary policy.
Even with the recent increase in expectations, the core inflation rate is still expected to hold steady this month. It now stands just above the ECB’s target, its fifth straight month above this mark. Core inflation is a uniquely important economic indicator because ECB officials so closely monitor it and use it as a guide to governmental monetary policy. The stay of core inflation above target is a sign of underlying pressures that may affect future interest rate decisions.
The wild card The recently passed German stimulus package, called the Energiewende, significantly complicates these developments. Yet it was touted as a great success almost six months ago. This large monetary move was meant to stimulate growth in the Euro Area. But right now, we don’t see any discernable signs of short term impact coming from this package. As any economist will tell you, the impacts of fiscal stimulus—especially the magic dust that can come from infrastructure spending—are notoriously long on the time lag. As a result, any potential impacts from Germany’s stimulus package are not expected to appear in economic data until the beginning of 2026.
While the ECB aims to maintain a specific inflation rate to ensure economic stability, the interplay between inflation expectations and actual rates poses challenges for policymakers. An increase in longer run inflation expectations together with steady broad based inflation shows an argument for a more hawkish tilt in upcoming meetings.