Introduction
On May 26, 2025, Eurostat released preliminary data indicating that the Eurozone’s consumer price inflation (CPI) fell to 1.9% year-over-year in May, marking a significant milestone: the first time inflation has dropped below the European Central Bank’s (ECB) 2% target since early 2021. This notable moderation in inflation came alongside a concerning drop in German industrial output, which declined by 1.4% month-over-month in April, underscoring the persistent challenges faced by Europe’s largest economy. The juxtaposition of cooling inflation and weakening industrial activity paints a complex picture for monetary policy in the Eurozone and adds pressure on the ECB to recalibrate its next move.
This dual development sent ripples through financial markets on Monday, particularly in equities, currencies, and bond yields, as investors reassessed the ECB’s trajectory amid signs of economic fragility even as inflation shows signs of control.
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Eurozone Inflation Returns to Target: Market Applauds the Milestone
According to preliminary estimates from Eurostat, the Eurozone CPI fell to 1.9% in May, down from 2.2% in April and below consensus forecasts of 2.0%. Core inflation, which excludes volatile items such as food and energy, eased to 2.3% from 2.6%, continuing its downward trajectory for the fifth consecutive month. The disinflationary trend was broad-based, with notable easing in energy prices (down 5.4% YoY) and a marked slowdown in services inflation (now at 3.1% vs. 3.4% in April).
The sharp drop in inflation revived expectations that the ECB might commence a rate-cutting cycle earlier than previously anticipated. Market pricing via overnight index swaps now suggests a 25 basis point cut in July, with a second move increasingly likely by October, especially if disinflation persists.
Christine Lagarde, President of the ECB, stated during a panel in Frankfurt, “The latest inflation figures are encouraging and consistent with our forecast that inflation would return to target in mid-2025. However, we remain data-dependent, especially given persistent economic slack in key economies such as Germany and France.”
German Industrial Output: A Red Flag for Eurozone Growth
The Bundesbank’s April report showed that German industrial production fell 1.4% month-over-month, sharply reversing the 0.5% gain in March and worse than the expected 0.3% decline. Year-on-year, output was down 4.1%, marking the steepest contraction since August 2023. The automotive and chemical sectors were particularly weak, reflecting both cyclical headwinds and structural challenges.
This downturn raised alarms about Germany’s broader economic trajectory, especially after recent data showed factory orders had also fallen 2.7% in March. The Ifo Business Climate Index, a key forward-looking gauge, dropped to 87.6 in May from 89.4, indicating declining optimism among firms.
With Germany representing nearly 30% of the Eurozone GDP, continued industrial weakness could weigh heavily on the region’s overall recovery. Analysts at ING noted, “The disconnect between stabilizing inflation and deteriorating industrial momentum complicates the ECB’s policy calculus. The risk of stagflation has not disappeared.”
Market Reaction: Mixed Signals Across Asset Classes
Equities
European equities opened the week mixed. The STOXX Europe 600 slipped 0.3%, with Germany’s DAX underperforming, down 0.9% on the back of the weak industrial report. Siemens AG and BASF SE led losses, shedding 2.1% and 2.4% respectively. However, interest-rate sensitive sectors such as utilities and real estate posted modest gains amid renewed expectations of rate cuts.
France’s CAC 40 fell 0.4%, while Italy’s FTSE MIB ended the day flat. London’s FTSE 100 rose 0.2%, supported by a rebound in mining stocks.
U.S. equities responded positively to the disinflation narrative. The S&P 500 rose 0.5%, led by gains in technology and consumer discretionary stocks. The Nasdaq Composite gained 0.7%, extending its month-to-date performance to +4.3%.
Currencies
The euro weakened against the dollar, falling to $1.0795 from $1.0840 on Friday, as markets priced in a higher likelihood of an ECB rate cut versus the Federal Reserve holding rates steady. The EUR/GBP pair also declined 0.4% to 0.8491, reflecting the euro’s broader softness.
The Dollar Index (DXY) strengthened to 104.25, up 0.3%, supported by relatively firm U.S. economic data released earlier in the week, including a better-than-expected services PMI of 54.2.
Bonds and Interest Rates
Eurozone sovereign bonds rallied. The German 10-year bund yield fell 9 basis points to 2.32%, its lowest level since February, while French and Italian yields dropped 7 and 10 basis points, respectively. Peripheral spreads narrowed, reflecting confidence in a more dovish ECB outlook.
In contrast, U.S. Treasury yields remained stable. The 10-year Treasury yield held at 4.28%, with markets awaiting further clarity on the Fed’s June meeting.
Money markets are now pricing in a 65% chance of a July ECB cut, up from 48% last week, and a full 50 basis points of easing by year-end.
Commodities
Brent crude oil declined 1.1% to $82.30 per barrel, amid concerns about weakening European demand and rising stockpiles in the U.S. West Texas Intermediate (WTI) dropped to $78.45 per barrel.
Gold prices, meanwhile, edged up 0.6% to $2,366 per ounce as falling euro yields increased demand for non-yielding assets. The precious metal continues to benefit from dovish central bank expectations and geopolitical uncertainties in the Middle East.
Industrial metals like copper also softened slightly, with COMEX copper down 0.5% to $4.68/lb, reflecting concerns about slower European manufacturing output.
Cryptocurrencies
Bitcoin traded slightly lower, slipping 0.7% to $66,800, while Ethereum dipped 0.4% to $3,380. Crypto markets were relatively muted, with investor attention focused more on macroeconomic developments than digital asset catalysts. Still, declining bond yields lent modest support to speculative assets broadly.
Economic Indicators and Policy Outlook
The ECB faces a policy crossroads. With inflation back at target and leading indicators of growth pointing downwards, calls are mounting for a more accommodative stance. The central bank’s June meeting will likely see revisions to GDP forecasts, with Germany’s output slippage a significant factor.
Eurozone composite PMI released last week stood at 50.1—barely in expansionary territory. The services sector remained resilient (PMI at 52.8), but manufacturing remains in contraction (PMI at 46.5).
Unemployment remains steady at 6.5%, but wage growth has slowed to 3.1% YoY from 3.7% earlier this year, further reducing inflationary pressures.
Meanwhile, the Federal Reserve is projected to keep rates steady until Q4, as U.S. inflation remains more persistent. The divergence in central bank paths could weigh on the euro in the coming months, particularly if German and Eurozone data continue to disappoint.
Geopolitical risks—especially surrounding Ukraine, Middle East tensions, and upcoming EU parliamentary elections—remain on investors’ radar, though none significantly moved markets today.
Conclusion
The Eurozone reaching its 2% inflation target for the first time in four years would typically be celebrated as a victory for the ECB’s tightening campaign. However, the simultaneous decline in German industrial output highlights the fragile balance between price stability and economic growth. Markets reacted accordingly—rewarding bonds and penalizing cyclical equities—while accelerating expectations for monetary easing.
Looking ahead, the ECB’s June and July meetings will be pivotal. Will policymakers prioritize inflation control now that the target has been met, or will they respond to deepening growth concerns, particularly in Germany? Investors should closely monitor incoming PMI data, updated wage statistics, and industrial orders across the bloc.
For now, the twin signals of easing inflation and faltering industrial activity present both relief and challenge. The path forward is one of delicate calibration, and financial markets are already bracing for the ECB’s next move.
