Eurozone core inflation is still high but is improving. Headline inflation is expected to drop more in the first quarter of 2026 due to the impact of past energy prices. The goal is to reach 2% inflation in the medium term. The European Central Bank (ECB) is still in a good position with its monetary policy. There is confidence that inflation expectations will stay around the target. The strong euro is mainly due to increased confidence in the EU, not just interest rate differences. We see a slow decline in headline inflation in the Eurozone, with predictions indicating it will continue to drop through early 2026. This decline is mainly due to comparisons with previous high energy prices, an effect that is often overlooked when looking at near-term price stability. However, while the headline numbers are decreasing, the underlying core inflation is still well above the target, although it shows some positive movement. This means that while external price pressures like oil and gas are diminishing, internal factors such as wages and service costs remain stubborn. This difference provides insight into the ECB’s approach. Although overall inflation is decreasing, the underlying data warrants caution, which informs their steady monetary policy—avoiding hasty decisions. Lagarde and her team have made it clear that they are committed to keeping inflation expectations stable. The message is that while the trend of decreasing inflation is encouraging, it doesn’t automatically justify loosening monetary conditions. Their main focus seems to be on controlling inflation, rather than stimulating the economy fully. Additionally, the euro’s stability is significant. Contrary to some market views, this stability isn’t solely about interest rates; it reflects growing investor confidence in the long-term EU economy. This positive sentiment is proving more impactful than changing yield dynamics, which have been narrowing recently. For strategic positioning, this stability matters. A stable exchange rate helps reduce imported inflation and improves pricing clarity, especially in sectors like manufacturing and distribution. Demand is gradually increasing, which may lead to lower input pricing pressures without extreme fluctuations. Markets expect financial conditions won’t ease quickly. The messages from Frankfurt have been steady: recent improvements in inflation are encouraging but not substantial enough for immediate changes. This cautious optimism is evident in the forward curves. Thus, focusing on interest rate differences among member states presents a clear opportunity. Market fluctuations concerning short-term expectations allow for relative value trades. Medium-term structures may benefit from adjusted expectations regarding future movements. Those trading options or swaps should monitor how lower energy cost uncertainty affects forward inflation breakevens. Reduced risks from energy crises impact how volatility is incorporated into caps, floors, and inflation-linked notes. Weaker implied moves challenge the need for tail hedges based on energy spikes. In the coming weeks, wage data from the service sector and consumption will provide more context on core inflation’s persistence. These factors are increasingly important for models based on forward guidance. Also, when considering market reactions, it’s crucial to understand that responses to positive surprises are now less reliant on significant macro changes and more focused on confirming stability. Overall, we expect fewer sudden shifts unless outside shocks disrupt these trends. With better-anchored expectations and lower volatility indicators, there’s room to build positions that depend on minor adjustments rather than drastic changes.

here to set up a live account on VT Markets now