Eurozone Harmonised Index of Consumer Prices (HICP) inflation on a month-on-month basis eased to 0.1% in May, down from 1% previously. The shift points to a slower pace of monthly price gains across the bloc compared with the prior reading.
The deceleration from 1% to 0.1% suggests May’s prices rose only marginally from April levels, tempering short-term inflation momentum as measured by HICP. The update applies to the aggregate euro area index and reflects the latest monthly movement in the harmonised gauge.
Market Implications and ECB Policy Outlook
This sharp drop in month-over-month inflation fundamentally shifts the outlook for European Central Bank policy. We believe this data point makes an ECB interest rate cut at the July or September meeting a very high probability. Markets must now re-price the entire forward curve for interest rates to reflect a more dovish central bank.
We are adjusting our positions in interest rate swaps to receive fixed rates, betting that future borrowing costs will decline. Overnight index swaps, which were pricing just one 25 basis point cut by year-end, are now quickly moving to price in two or even three. Euribor futures contracts should be bought, as their value will increase as expectations for lower rates solidify.
Currency, Equity, and Macro Backdrop
A dovish ECB will likely weaken the Euro, especially as the U.S. Federal Reserve is still signaling caution. We see the EUR/USD exchange rate, currently near 1.0950, as vulnerable to a move lower. We are therefore buying put options on the EUR/USD to profit from a potential decline towards the 1.0700 level in the coming weeks.
This environment is supportive for European equities, as lower borrowing costs boost corporate earnings and valuations. We are looking to sell out-of-the-money put options on the EURO STOXX 50 index. This strategy allows us to collect premium while positioning for a stable or rising stock market.
The inflation slowdown is happening alongside weakening economic data, with last quarter’s GDP growth being a meager 0.1%. Core inflation has also eased to 2.9% year-over-year, giving the ECB a clear runway to act. Historically, such as in the 2011-2012 period, the ECB has cut rates when faced with the dual threat of slowing growth and rapidly decelerating inflation.
