Christine Lagarde said 2025 could finally be the year the European Central Bank achieves its long-elusive 2% inflation target. “We have made significant progress in 2024 in reducing inflation,” she added. He saidHe added that the European Central Bank is committed to its strategy to achieve sustainable inflation stability at this goal.
However, it has not been a smooth road. The inflation rate fell to less than 2% last September, then rose again in recent months. Lagarde has warned of these fluctuations, but insists that the European Central Bank’s plan is working.
Interest rates have already been cut four times in quarter-point steps, and economists expect four more cuts by June. 2025 will indeed be a busy year for the ECB, with projects ranging from a digital euro to redesigned eurozone banknotes.
Inflation Expectations: Chaos to Control
Eurozone inflation was a game of blindfolded darts. Lagarde made it all clear in her speech on December 16: Forecasts were wildly inaccurate in the period from 2022 to 2023. ECB staff relied on machine learning models, which revealed that uncertainty about inflation expectations was four to four times higher. Five times than usual.
And it wasn’t just bad luck. The incoming data kept proving the predictions wrong. So, in September 2022, the ECB reset itself. The risk of inflation expectations spiraling out of control was too high, so they set a challenging timetable to reach the 2% level.
Public confidence was the goal, so there was no further movement towards the finish line. You succeeded. By late 2023, six consecutive forecasts showed inflation returning to target in 2025. Better yet, the forecasts are now much more reliable. Lagarde noted that uncertainty levels have fallen to pre-pandemic levels.
Real data supports this. Inflation forecasts for 2023 have become more accurate, especially for headline inflation. Core inflation expectations rose in 2024, while household surveys and market indicators showed inflation expectations at around 2% for the next three years.
What’s behind the numbers?
From rising energy prices to supply chain chaos, all the disruptions remain, making inflation more difficult to control. These were not short-term obstacles, but were structural challenges.
To address this problem, the ECB relied on a framework that includes three focus points: inflation expectations, core inflation dynamics, and the success of monetary policies.
Here’s the result: Measures of core inflation — which drives the long-term trend — have now contracted to historical averages. Most indicators range between 2% and 2.8%, a range that Lagarde considers a good sign.
The ECB’s continuous combined component of inflation (PCCI), a key measure, has remained steady at 2% since late 2023. However, some numbers remain stubborn. Domestic inflation, driven largely by services, is higher, hovering around 4%.
Lagarde pointed to repricing earlier in the year as the reason, but noted a sharp decline in services inflation momentum. Wage growth has also begun to slow. The European Central Bank’s wage tracker shows wage growth falling from 4.8% in 2024 to a projected 3% in 2025, a level in line with the 2% inflation target.
What is keeping policymakers awake?
Then there is the economy. It keeps Lagarde and her crew awake at night. Growth prospects for the Eurozone continue to shrink. Back in June 2023, the European Central Bank expected the region to grow by 1.5% in 2024. This has now fallen to just 0.7%. A large part of the problem is due to weak domestic investment.
Families, despite rising real incomes and high employment rates, save more than they spend. Lagarde described this as a result of high inflation in recent years.
Geopolitical uncertainty is another crucial factor. If the United States, the euro zone’s largest export market, leans toward protectionism under President Trump, growth will likely take a hard hit. Moreover, European exporters are vulnerable to changes in confidence in global trade, making this a double-edged sword for policymakers.
From Zero to Web3 Pro: The 90-Day Plan to Launch Your Career