In July, headline HICP inflation remained at the ECB’s 2% target instead of dropping to the expected 1.9%. Core inflation matched expectations at 2.3%, with less disinflation in energy and a rise in food inflation to 3.3%, an 18-month high.
Services inflation declined to a 40-month low of 3.1%, aligning with normalising wage growth trends. Goods inflation increased to a 16-month high of 0.8%, yet further downward pressure is anticipated due to weak US demand and increased competition from China.
ECB Governing Council’s Perspective
The ECB’s Governing Council is likely satisfied with July’s data, despite food inflation being a potential concern. There is no strong upward pressure from global agricultural prices, and services inflation is decreasing. Inflation is expected to fall below the ECB’s target soon, fueled by lower oil prices, a stronger euro, and stabilisation in core inflation.
The July inflation data reinforces our view that the European Central Bank’s next move will be a rate cut, not a hike. Markets are now pricing in a greater than 70% chance of a cut by the October 2025 meeting. This sets a clear direction for interest rate derivatives in the coming weeks.
We should anticipate continued downward pressure on European government bond yields. The German 10-year Bund yield has already fallen to 2.35%, its lowest since April 2025, and this trend has room to run. Positioning in interest rate futures that profit from lower rates is the primary response.
With services inflation cooling and the ECB’s path becoming more predictable, we expect market volatility to remain suppressed. The Euro Stoxx 50 Volatility Index (VSTOXX) is already near multi-month lows of 14.5. This suggests that strategies selling volatility, such as shorting straddles on major European indices, could be profitable.
Food Inflation and ECB’s Focus
We should not be overly concerned by the rise in food inflation to a 3.3% high. Looking back at the 2022-2023 period, we saw the ECB consistently look past temporary food and energy spikes to focus on core trends. We expect them to maintain this playbook, viewing the current food price pressure as transient.
The broader environment supports the case for lower inflation and a dovish ECB. Brent crude oil prices have recently fallen below $75 a barrel, which will directly weigh on future headline inflation numbers. A dovish ECB stance relative to other central banks may also put gentle pressure on the euro, further easing financial conditions.
