Euro zone inflation climbs to 2.4% as services prices stay stubborn

Annual inflation in the euro zone accelerated for a third straight month to 2.4% in December, according to the preliminary flash estimate from Eurostat. The reading matched the consensus of economists polled by Reuters and marked a clear step up from the revised 2.2% recorded in November. While the headline figure was widely anticipated, base effects from last year's energy price declines have been fading since September's 1.7% low, the persistence of underlying price pressures will keep the European Central Bank's governing council attentive at its upcoming meetings.

Core and services inflation refuse to budge

The more telling numbers sit beneath the headline. Core inflation, which strips out volatile energy, food, alcohol and tobacco, held at 2.7% for a fourth consecutive month. Services inflation, the component most closely watched by ECB policymakers for its link to domestic wage pressures, ticked up to 4% from 3.9% in November. Both figures met expectations, but the fact that neither is declining meaningfully suggests the last mile of disinflation remains the hardest.

Services prices have been the stickiest part of the basket throughout the post-pandemic inflation episode. They reflect labour-intensive sectors where wage growth, though moderating, still runs above the level consistent with the ECB's 2% medium-term target. The December reading reinforces the view that the central bank cannot declare victory on inflation until services momentum breaks decisively lower.

Germany and France pull in opposite directions

National data published separately this week revealed a widening divergence between the currency union's two largest economies. Germany's harmonised index of consumer prices (HICP) jumped to 2.8% in December, above the 2.6% analysts had expected, according to figures from Destatis. The statistical office corrected its initial estimate upward, underscoring the upward momentum in Europe's largest economy.

France, by contrast, recorded 1.8% inflation, below the 1.9% forecast in the Reuters poll. Data from Insee showed French price pressures continuing to ease, helped by regulated energy tariffs and a sharper slowdown in services momentum. The gap between the two, a full percentage point, illustrates how asymmetric the inflation landscape has become, complicating a single monetary policy for 20 countries.

ECB rate-cut path stays intact but pace debated

Financial markets have priced in a steady series of rate reductions from the ECB's current 3% deposit facility rate toward 2% by year-end. The December inflation print does not derail that expectation. As Haig Bathgate, director of Callanish Capital, told CNBC's "Squawk Box Europe": "There's now a lot more predictability in a lot of the data series we're seeing... the direction of travel of rates [lower] in Europe is much more predictable than say, the U.K."

Bathgate's point reflects a broader market consensus: the ECB's reaction function has become more transparent, and the inflation trajectory, while bumpy, is broadly following the central bank's own projections. The governing council has signalled it wants to be confident that inflation is returning to target sustainably before pausing, but it has also acknowledged that restrictive policy cannot be maintained indefinitely given the weak growth backdrop.

Services stickiness argues for gradualism

Jack Allen-Reynolds, deputy chief euro zone economist at Capital Economics, struck a more cautious note. In a note to clients he wrote: "Most important for the monetary policy outlook is that core inflation was unchanged at 2.7% for the fourth consecutive month... This won't stop the ECB from cutting interest rates further. The high level of services inflation is partly due to temporary effects that should fade this year. Meanwhile, the labor market has loosened, wage growth is slowing and the growth outlook is weak."

Allen-Reynolds expects the ECB to keep cutting "only slowly" despite the poor economic outlook. His argument rests on the composition of services inflation: some components, such as package holidays and insurance, have been distorted by post-pandemic catch-up effects and methodological quirks that should unwind. But until they do, the ECB will likely move in 25 basis point increments rather than the larger steps some doves have advocated.

Growth backdrop remains fragile

The euro zone economy expanded by 0.4% in the third quarter, a respectable figure on paper but one that masks considerable weakness beneath the surface. Manufacturing, particularly in Germany, has been in contraction for much of the past two years. The Purchasing Managers' Index for the sector has lingered below the 50 threshold separating expansion from contraction, weighed down by high energy costs, weak Chinese demand and structural competitiveness challenges.

Political instability adds another layer of uncertainty. France and Germany, the union's twin engines, both face fragmented parliaments and uncertain fiscal trajectories after turbulent elections in 2024. The potential for escalating trade tensions under the incoming administration of U.S. President-elect Donald Trump, who has threatened broad tariffs on European goods, could further dent export-dependent manufacturers.

Euro holds ground but parity risk lingers

The single currency reacted calmly to the data, holding early-morning gains against the U.S. dollar to trade 0.33% higher at $1.0424 at 10:43 a.m. in London. The relative stability reflects the market's view that the ECB and Federal Reserve are on diverging paths: the ECB easing steadily, the Fed potentially pausing or moving more slowly after a strong U.S. labour market report last week.

Some strategists continue to flag the risk of euro-dollar parity if the Fed proves significantly more hawkish than currently priced. The interest rate differential between the two currency blocs has been a primary driver of the exchange rate over the past two years, and any repricing of Fed expectations tends to move the pair sharply. For now, the euro's resilience suggests markets are comfortable with the ECB's gradualist script.

The last mile remains the longest

December's inflation report is neither a shock nor a surprise. It is, instead, a confirmation of the uncomfortable reality the ECB has been describing for months: the final stretch of disinflation is grinding, asymmetric across countries, and dominated by services prices that respond slowly to monetary policy. The central bank's challenge is not whether to cut, that decision is effectively made, but how to communicate a gradual pace without sounding either complacent about inflation or indifferent to growth.

For households and firms, the practical implication is that borrowing costs will decline only incrementally. Mortgage rates, business lending spreads and consumer credit terms will follow the deposit facility rate down, but the transmission will be slow and uneven across the currency union. The divergence between Germany's 2.8% and France's 1.8% inflation means the real interest rate faced by borrowers differs markedly depending on where they operate, a structural feature of monetary union that no single policy rate can resolve.

The next flash estimate, for January 2025, is due on 31 January, one day after the ECB's first rate decision of the year. That timing is coincidental but convenient: it will give the governing council a near-real-time check on whether the services stickiness that defined 2024 is finally loosening its grip.