Germany's inflation remained unchanged at 2.3% year-on-year in February 2025, as per the latest flash estimate. Core inflation, which excludes volatile food and energy prices, fell from 2.9% to 2.6% YoY, providing some relief to the European Central Bank (ECB) as it prepares for its upcoming rate decision. The broader Eurozone inflation measure also held steady at 2.8% YoY, reinforcing expectations of an imminent interest rate cut.

Inflation trends and economic indicators

Several factors contributed to the unchanged German inflation rate. Regional data indicates that falling energy prices, alcohol, healthcare, and household goods helped offset rising food prices and services inflation. While services inflation is easing gradually, it remains a key area of concern.

On the economic growth front, Germany’s latest retail sales and labour market data cast doubts on a consumer-driven recovery. Retail sales increased by just 0.2% month-on-month in January, failing to compensate for the weak Q4 2024 performance. The labour market, though improving slowly, is yet to show substantial signs of recovery.

Inflation outlook: A balancing act

Looking ahead, the trajectory of German inflation in 2025 will be influenced by two contrasting forces.

1. Energy prices remain volatile – They have fluctuated significantly in recent months and are highly dependent on geopolitical factors. Any escalation in global tensions could push energy prices higher, affecting headline inflation.

2. Labour market and wage pressures – A cooling labour market is expected to ease wage-driven inflation, reducing overall inflationary pressures. However, the delayed impact of higher service costs could continue to drive core inflation.

3. Industry price expectations – A recent rise in selling-price expectations in the industrial sector raises concerns about potential inflationary pressures, particularly if new European tariffs come into play.

Based on these factors, German inflation is projected to stay within the 2% to 2.5% range for the rest of 2025, aligning with the ECB’s objective of keeping inflation “close to but above 2%.”

ECB rate cut expected next week

The latest inflation data from Germany, France, and Italy strengthens the case for an ECB rate cut next week. The central bank is widely expected to reduce rates by 25 basis points, bringing the policy rate down to 2.5%.

However, the bigger question remains – what’s next for the ECB? While 2.5% is near the upper end of the neutral interest rate range, some ECB officials, including Isabel Schnabel, have pushed back against further cuts. The upcoming ECB meeting will be crucial in determining whether the central bank softens its stance from “restrictive” to a more neutral position.

Given the structural weakness of the eurozone economy, potential trade restrictions, and a weakening labour market, further rate cuts down to 2% may be necessary. This would ensure that interest rates are not just neutral but potentially accommodative, providing much-needed support to the eurozone economy in 2025.

Conclusion

The unchanged German inflation rate in February 2025 signals stability but also lingering challenges for policymakers. While the ECB is likely to cut rates next week, the path beyond that remains uncertain. Fluctuating energy prices, labour market trends, and industrial cost pressures will play a crucial role in shaping Germany’s inflation outlook and the ECB’s monetary policy decisions in the coming months.

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