Euro zone inflation dips, growth holds up, backing ECB's sanguine narrative

By Balazs Koranyi

FRANKFURT, Jan 6 (Reuters) - Inflation slowed more than expected in some of the euro zone's biggest economies last month while economic growth held up, confirming views that price pressures have largely dissipated and the bloc continued to display resilience.

Euro zone growth has been surprisingly robust throughout 2025 as domestic consumption filled the gap left by falling exports, and inflation has stabilised around the European Central Bank's 2% target, creating what some economists describe as a goldilocks moment or a central banker's nirvana.

Ending this surprisingly healthy year, inflation slowed sharply in Germany, and eased in France and Spain, indicating that price growth for the bloc as a whole could dip below the 2% expected by economists when Eurostat publishes figures on Wednesday.

GERMAN INFLATION DOWN SHARPLY

Inflation in Germany, the bloc's biggest economy, slowed to 2% from 2.6%, falling below expectations for 2.2% while in France it slowed to 0.7% from 0.8% and in Spain to 3% from 3.2%.

This dip could then herald a long string of below-target readings in the coming months before a return to target in early 2028, according to the ECB's own projections.

"This disinflationary story (in Germany) is also supported by the ongoing drop in producer and import prices, normally a good leading indicator for headline inflation," ING economist Carsten Brzeski said.

"In the longer run, however, the incoming fiscal stimulus should lead to new inflationary pressures, at least in certain sectors," he added.

ECB FIRMLY ON HOLD

Policymakers have appeared relatively unconcerned about the below-target readings in the coming years and signalled that there was no appetite at all to lower interest rates any further.

Part of the sanguine approach is that growth remains relatively strong and while no boom was in sight, the downside risk was also limited.

This was also confirmed on Tuesday by PMI data, which showed that the bloc expanded at a slower pace last month but ended 2025 with its strongest quarterly growth in more than two years as solid momentum in services offset a manufacturing contraction.

Investors also believe this narrative and no interest rate change is priced in for this year, suggesting that a steady 2% deposit rate is seen as the most likely outcome for each of the ECB's eight meetings this year.

Still, this outlook is fraught with risk.

Energy prices are low, wage growth is slowing, manufacturing remains weak and Germany keeps skirting a recession, creating plenty of downside risk for inflation.

However, geopolitical tensions keep upsetting global value chains, government spending is rising quickly this year and the labour market is tight, putting upward pressure on prices.

These opposing forces suggest that the outlook could turn quite suddenly and policymakers will not give any meaningful policy guidance beyond the immediate future.

(Reporting by Balazs Koranyi; Editing by Emelia Sithole-Matarise)