Eurozone’s preliminary Consumer Price Index (CPI) for May has risen by 1.9% year-on-year, which is slightly lower than the expected 2.0%. This differs from April, where the rate was higher at 2.2%, indicating a slowdown in inflation. Core CPI, which excludes unpredictable food and energy prices, increased by 2.4%, below the expected 2.5% and down from April’s 2.7%. These numbers hint at easing inflation pressures, which may lead the European Central Bank to consider a rate cut in their next meeting.

Cooling Inflation Measures

We are observing a continued cooling in both overall and core inflation in the euro area. The flash estimate for May confirmed a drop from the previous month. Headline CPI fell to 1.9% year-on-year—just a bit shy of predictions, but enough to suggest that pressures on consumer prices might be decreasing more quickly than expected. Core inflation, which policymakers prefer because it excludes more volatile components like food and energy, also eased more than anticipated. The decline from 2.7% in April to 2.4% in May indicates that underlying pricing trends are softening. Traders should pay attention. If we view the gap between expectations and reality as part of a larger trend, we see a gradual shift in monetary policy assumptions. The European Central Bank now has additional evidence to adopt a slightly more accommodating stance. Before this, markets were already pricing in the chance of a rate cut, but this data boosts confidence—especially if wage growth and services inflation remain controlled in upcoming reports. In terms of positioning, shorter-term rates are adjusting to this possibility, with swaps markets starting to show a stronger likelihood of a move at the next meeting. German bunds and short-term sovereign spreads have begun to reflect these changes, with tighter ranges and lower yields observed in the 2Y to 5Y segment.

Future Outlook

Looking ahead, attention may shift to service cost disinflation and monthly wage negotiations in key member states like Germany and France. If unit labor costs stabilize or decrease, this could further push expectations for a rate cut. It wouldn’t make sense to bet against softening policy if this trend continues. However, the ECB remains alert to external shocks and geopolitical issues, so even though inflation seems to be easing, caution is still needed. At this point, there’s no need to significantly change implied volatility, but interest in gamma positioning may rise depending on comments from ECB members leading up to the decision. If Lagarde and her team shift their messaging from a wait-and-see approach to one of action, we could see the curve react. We also note that recent movements in EUR-denominated rates have been more influenced by macro data than central bank comments. This trend may continue in the short term, although liquidity during the summer could impact flow-driven signals. Regarding hedging strategies, there’s an opportunity to move away from higher convexity shorts into spreads that benefit from a flattening euro curve. Those who stick to April’s pricing assumptions might find themselves on the wrong side of the next CPI revision or producer price updates, especially with seasonal effects starting to emerge in the third quarter. In summary, we have data moving gently towards a direction that requires us to stay responsive. If future Eurozone reports confirm this trend (and that’s a significant “if” based on wage data), we can expect further shifts in the front end of the curve that favor carry and roll-down strategies heading into summer. Create your live VT Markets account and start trading now.

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