Eurozone Inflation Falls Below ECB Target, Paving Way for Rate Cut
CPI eases to 1.9% in May, marking first sub-2% reading since 2024 as services inflation drops and energy prices slide.
The Eurozone’s inflation rate fell below the European Central Bank’s target for the first time in eight months, bolstering expectations of a monetary policy rate cut later this week. According to a flash estimate by Eurostat, consumer price inflation in the euro area slowed to 1.9% year-on-year in May 2025, down from 2.2% in April and below consensus forecasts of 2.0%.
This decline places inflation back under the ECB’s medium-term target of “close to but below 2%,” marking a significant psychological and policy milestone after nearly three years of above-target inflation. The easing has been driven by a broad-based moderation, but most notably by a sharp deceleration in services inflation, which fell to its lowest level since March 2022.
Markets now widely anticipate that the ECB will announce a 25 basis point rate cut at its policy meeting later this week, a move that many economists believe will mark the final step in the current easing cycle before the central bank pauses to assess economic conditions.
Services Inflation Cools Sharply
The most notable element in the May data is the pronounced slowdown in services prices, which had been a persistent inflationary pressure point. Services inflation dropped to 3.2% in May, down from 4.0% in April, indicating a substantial loss of momentum in sectors such as hospitality, health care, education, and transportation.
ECB officials had repeatedly flagged services inflation as a key barrier to monetary easing. The recent softening, therefore, provides critical support for a dovish pivot. Analysts suggest that the slowdown may be tied to waning wage pressures, diminished post-pandemic demand booms, and reduced tourism-linked surges, particularly in southern Europe.
“Service inflation’s return to trend is exactly what the ECB needed to see,” said Carsten Brzeski, Global Head of Macro at ING. “It opens the door to a rate cut and reaffirms that underlying inflationary forces are cooling without a crash in demand.”
Energy and Industrial Goods Keep Price Pressures Muted
Energy prices continued to act as a deflationary force, with the index for energy falling 3.6% year-on-year. Lower wholesale gas and electricity prices—along with mild weather and expanded renewable capacity—have helped anchor household utility bills. Petroleum products also saw a price dip as global oil markets stabilized near $63 per barrel.
Non-energy industrial goods inflation held steady at 0.6%, indicating continued softness in sectors such as automobiles, home appliances, and clothing. The stagnation suggests that supply chain normalization and subdued retail demand are keeping price hikes in check, even as producer input costs stabilize.
In contrast, food, alcohol, and tobacco inflation ticked up to 3.3% from 3.0%, driven by a rise in processed food and beverage costs, though the category remains relatively stable compared to peaks in early 2023.
Core Inflation Falls to 2.3%
Core inflation, which excludes volatile food and energy components, fell to 2.3%, the lowest reading since January 2022. This figure is closely watched by the ECB as a measure of persistent price pressures and is often used to assess medium-term inflationary risks.
The downtrend in core inflation further supports the case for policy loosening and suggests that second-round effects from past energy shocks and wage settlements are fading.
“Inflation persistence is fading faster than the ECB initially expected,” said Katharina Utermöhl, Senior Economist at Allianz. “But policymakers will want to see confirmation in the June and July prints before committing to a full pivot.”
Market Reaction and Policy Expectations
The euro weakened slightly against the U.S. dollar following the data release, falling to $1.067, as bond yields across the bloc edged lower. The yield on the German 10-year Bund dropped by 6 basis points to 2.28%, reflecting investor confidence in imminent ECB easing.
Futures markets now fully price in a 25 basis point rate cut, with about 60% probability of a second cut by September. Beyond that, expectations diverge due to uncertainty over fiscal conditions and global trade dynamics.
ECB President Christine Lagarde is expected to reaffirm a data-dependent approach, signaling that the June cut will not necessarily be followed by a prolonged easing cycle. “The ECB is likely to deliver a cut and then pause to assess the strength of disinflation and any external shocks,” said Marco Valli of UniCredit.
Broader Economic Outlook
The disinflationary trend comes amid a fragile recovery in the eurozone. GDP rose just 0.2% in Q1 2025, with Germany narrowly avoiding recession and southern economies—especially Spain and Greece—providing most of the growth momentum.
Soft investment activity, tight credit conditions, and slow productivity gains are weighing on potential output. Policymakers remain cautious about over-stimulating in a structurally low-growth environment.
Nonetheless, falling inflation and potentially lower borrowing costs should provide modest relief for households and businesses, supporting real wage growth and domestic demand in the second half of 2025.
Conclusion
The return of eurozone inflation to sub-2% territory marks a turning point for the European Central Bank’s policy stance and underscores the success of its restrictive rate regime in taming pandemic-era price surges. However, the ECB’s task is far from over.
Navigating the path between encouraging recovery and avoiding premature easing will require prudence and flexibility, particularly in a global environment still characterized by geopolitical instability and uneven growth.
With the May inflation print delivering the green light, all eyes now turn to Frankfurt—where the ECB is expected to make its first rate cut in nearly two years, signaling the next phase in Europe’s monetary journey.