News & Analysis

Inflation data in the eurozone is finally showing signs of breaking lower, to the relief of ECB policymakers. Headline inflation in Germany fell from 6.1% to 4.5% YoY, its lowest reading since Russia’s invasion of Ukraine. Meanwhile, despite a pick-up in headline inflation in Spain, from 2.4% to 3.2% YoY due to base effects, core inflation pressures remained subdued with September’s reading printing at -0.1% MoM.

Despite the positive readings, which come just after the ECB called an unofficial end to its hiking cycle in our view, the party poppers won’t be getting pulled at the central bank’s headquarters in Frankfurt.  That’s because the improved inflation data has printed at a time when external conditions have led to a deterioration in the inflation outlook, with oil benchmarks cracking year-to-date highs and headlines aplenty over looser fiscal policy in 2024. The conflicting dynamics are best evidenced by the reaction in eurozone bond markets, where the bear steepening trend was largely uninterrupted by the publication of the inflation data.

Past inflation conditions improve in the eurozone 

Starting with the flash Spanish numbers, which came out at 08:00 BST this morning. Headline inflation rose from 2.6% to 3.5% YoY, largely due to negative base effects as electricity prices fell sharply in September 2022, leading to a 0.7% MoM drop in headline CPI, while they rose significantly last month. Furthermore, fuel prices also rose last month. The bad news largely stops there, however, as the pace of the overall inflation remained relatively low at just 0.2% MoM, while the core figure, which strips out the energy effects, indeed fell 0.1% MoM. While Spain’s statistics agency INE doesn’t provide a component breakdown on the flash numbers, it is reasonable to assume that the bulk of the core inflation pressures are now in the rearview mirror given PPI printed is now in negative territory and peak tourism season is now over.

This should mean core inflation is likely to fall further from the current rate of 5.8% YoY barring any significant second round energy effects.

A similarly positive outcome was seen in the German data, released at a national level at 13:00 BST but drip fed to markets from the early hours of the day via regional data. Here headline inflation fell from 6.1% to 4.5%, slightly below expectations, with the month-on-month data printing in line at 0.3%. On a harmonised basis, the data fell two tenths below expectations at 4.3% YoY, with a monthly reading of 0.2%. Unlike in Spain, base effects in Germany helped bring down headline inflation, with energy inflation falling a percentage point in September to 8.3% YoY and food inflation falling 1.5pp to 7.5%. Furthermore, services CPI also fell significantly on positive base effects, from 5.1% to 4.0% YoY. While Germany’s statistics agency doesn’t provide an official core CPI reading, it is again reasonable to assume that core inflation pressures have cooled.

But ECB celebrations to remain on pause, with a policy of hold and hope likely to remain 

The latest data would have been music to the ECB’s ears if it wasn’t for the recent deterioration in the inflation outlook. Especially after it hiked the deposit rate to 4% last week in what is likely to be the last hike this cycle as the eurozone economy now stares down a relatively bleak growth outlook. However, with oil benchmarks breaking fresh one-year highs, and headlines plentiful that some eurozone nations are set to publish budget deficits that exceed the European Commission’s fiscal rules, the champagne is likely to remain on hold in Frankfurt as returning inflation to target remains some way away. While the latest external developments don’t change much in terms of near-term policy, with the ECB likely to keep policy unchanged while simultaneously hoping a recession is avoided and inflation conditions improve, it definitely adds to the uncertainty over how long the ECB can maintain the higher for longer narrative into 2024.

Additionally, despite rates expected to remain on hold in the coming months, policymakers at the ECB won’t be able to relax just yet as developments in eurozone bond markets are likely to test the efficacy of PEPP reinvestments in containing market fragmentation for the first time.

BTP-Bund spread is on a highway to the danger zone 




Simon Harvey, Head of FX Analysis



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