Impact of Germany's Inflation Slowdown Exceeding Expectations on the ECB's 2025 Monetary Policy Path

According to preliminary data from Germany’s Federal Statistical Office, Germany’s December 2024 year-on-year inflation rate initial value dropped to

, a significant decline from November’s 2.3% and lower than the market expectation of 2.0%. This is the first time Germany’s inflation rate has fallen below the ECB’s 2% target midpoint since September 2024 [1].

Structural and Trend Observations (compiled based on public online information):

• A sharp slowdown in goods inflation was the main driver; weaker energy and some commodity prices transmitted to the import and consumer goods ends, contributing significantly to the overall decline [1].
• Service inflation pressure was relatively more stubborn, but there were signs of easing as wage growth and marginal demand slowed.
• On the demand side, the Eurozone’s Q3 GDP grew by approximately 0.3% quarter-on-quarter, indicating economic momentum was better than previously expected; meanwhile, fiscal and structural policies in core countries like Germany provided some support to the economy [1].

Germany’s inflation slowdown exceeding expectations confirms the easing of inflationary pressure in Europe, but it also reminds us that the stickiness of core service prices still needs attention. This provides more flexible operating space for the ECB’s policy adjustments under the “data-dependent” framework.

• Deposit facility rate:
  2.0%
• Main refinancing rate:
  2.15%
• Marginal lending rate:
  2.4%

The ECB completed several rate cuts in 2025 (and kept rates unchanged for consecutive meetings), with the overall interest rate level significantly lower than earlier periods; the market generally believes the current “easing window” is nearing its end, and the next phase of policy will focus on observation and fine-tuning [1].

• Inflation: Expected to be slightly below 2% in 2026-2027 and return to around the 2% target in 2028 [1][2].
• Economic growth: Eurozone GDP is expected to grow by approximately 1.4% in 2025, 1.2% in 2026; around 1.4% in 2027-2028, indicating economic resilience [1].

• Officials are generally “willing to accept short-term inflation below target” (if the deviation is not large) and emphasize “all options are on the table” [1][2].
• Some hawkish voices (such as Isabel Schnabel) are open to future rate hikes, but most governors still stress that “discussions on rate hikes are premature” and prefer to observe data evolution in the medium term [1][2].

• Traders’ expectations for further rate cuts have cooled significantly; the implied probability of rate hikes by the end of 2026 in the money market is approximately
  16-30%
  (slight differences across sources) [1][2].
• Most institutions predict that interest rates may enter an upward phase from the end of 2026 to early 2027, provided that inflation steadily returns to around 2% and economic momentum continues [1][2].

• Support from inflation stepping down:
  Germany’s 1.8% inflation reading strengthens the robustness of the overall inflation downward path in the Eurozone, increasing the ECB’s tolerance for slightly below-target inflation in 2025, which theoretically retains space for “additional easing if necessary” [1].
• But the rate-cut cycle is closer to the end:
  Given officials’ public statements (the rate-cut cycle “is most likely over”) and the market’s weakened expectations for further rate cuts, although Germany’s inflation slowdown does not rule out a small additional easing (such as a one-time 25 basis points) in extreme cases, it is not the baseline scenario [1][2].

• Current baseline:
  Overnight markets imply a 16-30% probability of rate hikes by the end of 2026, and if hikes occur, they are more likely to happen at the
  end of 2026 or early 2027
  [1][2].
• Time-lag effect of inflation decline on rate hikes:
  If inflation remains moderately low (around 1.8-2.0%) in 2025, the ECB will tend to wait for clearer evidence of “sustainable anchoring at 2%” before starting rate hikes. This may push the first hike timing from the market’s bet of “early 2026” to a window closer to
  2027
  .

• Neutral interest rate perspective:
  Assuming the Eurozone’s nominal neutral interest rate is in the range of 1.5-2.0%, the current deposit rate of 2.0% is slightly above the neutral upper limit, with room for a slow return to neutral (provided there is no unexpected rebound in inflation) [2].
• Data dependence and communication:
  The ECB will continue to use the wording of “meeting-by-meeting decisions” and “data dependence” to avoid preset paths and maintain policy flexibility [2].

• Interest rate swaps:
  Market pricing for further rate cuts has basically been cleared, shifting to scenario trading of “policy rates remaining unchanged for a longer period + possible future rate hikes” [1][2].
• Treasury curve:
  Germany’s 10-year Treasury yield rose slightly (by about 1 basis point to approximately 2.87%) after the recent meeting, reflecting the market’s consensus on “policy bottom” and “future upward shift in yield中枢” [1].
• Exchange rate and asset correlation:
  The euro against the dollar rebounded after the announcement of “unchanged rates + upward revision of growth”; if inflation remains moderate and economic resilience continues, the euro may be moderately strong in the medium term, but the pace is also highly influenced by the Fed’s policy cycle [1].
• Risk assets:
  Cooling rate-cut expectations and rising rate-hike expectations may increase financing costs and volatility, forming a valuation constraint on high-valuation sectors (growth, technology); relatively friendly to defensive assets (high-quality dividends, short-duration high-rated bonds).

• Baseline scenario (probability ~60%):
  Inflation fluctuates around 1.8-2.0% in 2025, and the economy maintains moderate resilience; the ECB will
  focus on observation
  throughout the year, keeping interest rates around current levels,
  without further rate cuts
  and not starting rate hikes yet; if inflation steadily returns to 2% from the end of 2025 to early 2026, then the first rate hike will be
  launched at the end of 2026 or early 2027
  .
• Dovish scenario (probability ~25%):
  If geopolitical shocks or weak external demand lead to longer-term low inflation, a small additional rate cut (such as a one-time 25 basis points in mid-2025) cannot be ruled out, followed by maintaining a neutral-low level until 2027, with the rate hike timing delayed accordingly.
• Hawkish scenario (probability ~15%):
  If service inflation is unexpectedly sticky or energy prices rise again, the ECB may stop “keeping rates unchanged” at the end of 2025 or early 2026, shift to more hawkish forward guidance, or even start rate hikes in 2026.

• Wage growth and service inflation evolution
• Geopolitical and energy supply shocks
• Fiscal policy (stimulus intensity and debt sustainability in Eurozone countries)
• Fed’s policy cycle and its spillover effects on global financing conditions
• Speed and extent of market repricing of the central bank’s path

• Interest rate bonds and credit bonds:
  Maintain neutral to short duration exposure, lock in high-quality and high-liquidity positions; long-term interest rates may rise moderately with “policy bottom” and “future upward shift in yield中枢”, so need to control long-bond duration risk.
• Exchange rate and asset allocation:
  The euro against the dollar may rise gradually in震荡, but is influenced by the Fed’s path; moderately focus on value and defensive sectors with stable cash flow and low interest rate sensitivity.
• Policy and trading rhythm:
  In the transition period of “end of rate cuts, pending rate hikes”, market volatility may rise; avoid over-betting on one-way directions, and pay attention to marginal changes in data and central bank communication signals.

Germany’s inflation slowdown exceeding expectations further confirms the easing of inflationary pressure in the Eurozone, providing the ECB with more从容 policy space. In 2025, the ECB’s policy will tend to:

• Maintain interest rate stability (neutral to tight stance)
  , not rush to further rate cuts, but retain data-dependent flexibility;
• Take medium-term inflation anchoring as the core target
  , and maintain a certain tolerance for short-term slight deviations below the target;
• Wait for clearer evidence of inflation stabilizing at 2% in 2026-2028
  before starting slow and gradual rate hikes.

For the whole of 2025, “keeping rates unchanged” is still the baseline scenario; if extreme exogenous shocks occur, it may trigger one-time easing marginally. Although market bets on “earlier rate hikes” have heated up, more persistent inflation decline confirmation and economic resilience support are still needed, and the first rate hike is more likely to occur at the

.

[1] Jinling API Data
[2] Yahoo Finance - Germany’s December year-on-year inflation rate initial value drops to 1.8%, lower than expected (https://hk.finance.yahoo.com/news/經濟-德國12月年通脹率初值降至1-8-低於預期-134509306.html)
[3] Yahoo Finance - ECB rates frozen for four consecutive times, market bets on possible rate hikes in 2026 (https://hk.finance.yahoo.com/news/歐洲央行利率連四凍-市場押注2026年可能升息-135724475.html)
[4] Yahoo Finance - ECB officials reportedly believe the rate-cut cycle is most likely over (https://hk.finance.yahoo.com/news/歐洲央行官員據悉認為降息周期很可能已經結束-155359708.html)
[5] Yahoo Finance - Stop waiting for rate cuts? Global monetary easing cools, market bets “next step may be rate hikes” (https://hk.finance.yahoo.com/news/別再等降息了-全球貨幣寬鬆降溫-市場押-下-步可能升息-133008956.html)
[6] Bloomberg - ECB Officials Say Cycle of Rate Cuts Is Most Likely Over (https://www.bloomberg.com/news/articles/2025-12-18/ecb-officials-say-their-cycle-of-rate-cuts-is-most-likely-over)
[7] Bloomberg - Global Rates: Policy Cycle Is Losing Steam (https://www.bloomberg.com/news/newsletters/2025-12-19/global-rates-policy-cycle-is-losing-steam)
[8] Bloomberg - ECB Holds Rates With Growth Firmer and Inflation Near Target (https://www.bloomberg.com/news/articles/2025-12-18/ecb-holds-rates-with-growth-firmer-and-inflation-near-target)
[9] Bloomberg - Lagarde Says ECB Does Not Have a Set Path for Rates (https://www.bloomberg.com/news/live-blog/2025-12-18/ecb-interest-rate-decision-euro-lagarde-press-conference-ecb-policy-decision-live-updates)
[10] Yahoo Finance - Will it be a hike next year? Five questions for the ECB (https://uk.finance.yahoo.com/news/hike-next-five-questions-ecb-050120587.html)