Eurozone core inflation remains elevated but is progressing positively. Headline inflation is projected to decrease further in the first quarter of 2026, influenced by the energy price base effect, aiming to return to 2% over the medium term.

The European Central Bank (ECB) maintains a favourable position regarding monetary policy. There is assurance that inflation expectations will not fall below the target. The strong euro exchange rate results more from a positive confidence shock in the EU than from interest rate differences.

Eurozone Inflation Trends

We are currently observing a gradual descent in headline inflation across the Eurozone, with forecasts indicating a continued drop through early 2026. This reduction appears largely shaped by comparisons to earlier periods of high energy prices, a statistical effect often underestimated when assessing near-term price stability. Importantly, while these headline figures are falling, underlying core inflation readings remain notably above target, despite showing some encouraging directional movement.

This suggests that while external price pressures—such as oil and gas—are easing, internal factors like wages and services costs are still sticky. It’s this divergence between the two that offers clarity into the European Central Bank’s thinking. While overall inflation is heading down, underlying data reinforces a degree of caution. That caution supports their current monetary stance: steady, not hasty.

Lagarde and her colleagues have clearly articulated their commitment to anchoring inflation expectations. The message is: the disinflation trend is welcome, but not sufficient on its own to trigger an immediate loosening of conditions. Inflation control, rather than full economic stimulation, appears to remain their preferred course.

Moreover, we are seeing the euro hold firm, a development that, contrary to some market narratives, isn’t wholly rooted in interest rates. Rather, it reflects increasing investor confidence in the EU economy’s medium-term prospects. That sentiment is proving more influential than relative yield dynamics, which have narrowed in recent months.

Strategic Market Positioning

For strategic positioning, this matters. Exchange rate stability tends to suppress imported inflation and provides greater visibility in pricing models—particularly in currency-sensitive sectors like manufacturing and distribution. With demand-side strength building gradually, but not surging, pricing pressures for inputs may ease without extreme volatility.

Rates markets seem increasingly convinced that financial conditions will not be loosened at a rapid pace. The tone from Frankfurt has been consistent: the recent progress in inflation is encouraging, but not decisive. This cautious optimism looks to be well-reflected in the forward curves.

As such, we see a clear opportunity in focusing on rate dispersion across member states. Market volatilities around shorter-term expectations provide breathing room for relative value trades. Medium-horizon structures may benefit from the recalibration of expectations about the timing and magnitude of future movements.

Those trading options or swaps should pay attention to how reduced uncertainty around energy costs plays into forward inflation breakevens. Lower perceived energy risk compresses tail scenarios. That affects how volatility is priced into caps, floors, and inflation-linked notes. Flatter implied moves also challenge the logic behind tail hedges based on energy spikes.

In the coming weeks, data from service-sector wages and consumption will shed more light on the persistence of core inflation. These inputs are increasingly relevant for models built on forward guidance. And as we scan for market reactions, it’s important to note that reactions to positive data surprises now hinge less on large macro changes and more on confirming stability.

Overall, we anticipate fewer abrupt moves—unless external shocks offset these trends. With expectations better anchored and volatility indicators subdued, there’s space to structure positions that rely on minor shifts rather than dramatic pivots.

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