Eurozone inflation exceeded forecasts in January, reaching 2.5%, but the euro weakened as fears of US tariffs overshadowed expectations of a hawkish ECB response. European stocks tumbled, with auto shares hit hardest, while bond yields fell as investors sought safety.
Eurozone inflation rose more than expected in January, adding to economic uncertainty as investor sentiment remained pressured by the looming threat of US tariffs on Europe.
Annual inflation in the euro area rose to 2.5% in January 2025, up from 2.4% in December, according to a flash estimate from Eurostat. The reading exceeded economist forecasts, which had anticipated inflation to remain unchanged at 2.4%, marking the highest level since July 2024.
Core inflation, which excludes volatile energy and food prices, remained stable at 2.7%, defying expectations of a slight decline to 2.6%.
Among the key components of inflation, services recorded the highest annual rate at 3.9%, though slightly lower than the 4.0% recorded in December. The cost of food, alcohol and tobacco increased by 2.3%, a slowdown from the 2.6% seen the previous month.
Energy prices, however, surged to 1.8%, rebounding sharply from the 0.1% recorded in December, while inflation for non-energy industrial goods remained steady at 0.5%.
Among eurozone member states, Croatia posted the highest annual inflation rate at 5.0%, followed by Belgium at 4.4% and Slovakia at 4.1%. Ireland, Finland and Italy recorded the lowest inflation rates at 1.5%, 1.6% and 1.7%, respectively.
On a monthly basis, Slovakia and Lithuania experienced the sharpest price increases, both rising by 1.6%.
Market reaction: euro under pressure amid trade tensions
Despite the stronger-than-expected inflation data, the euro struggled to gain traction and remained under pressure due to growing concerns over US trade policy. The currency briefly found support at 1.0230 against the US dollar but was still down 1.2% on the day. Earlier in January, it had fallen to 1.0175, its lowest level since November 2022.
The US dollar strengthened broadly, rising 0.7% against the British pound. The Canadian dollar weakened by more than 1%, while the Mexican peso dropped 2.1% as traders reacted to trade tensions.
The currency market volatility came after US President Donald Trump reiterated threats to impose tariffs on the European Union. The administration had already enacted tariffs of 25% on Canadian and Mexican goods and 10% on Chinese imports, with Trump warning that Europe could be next.
Although he did not specify a timeline, he stated that new tariffs would be implemented “pretty soon”.
Analysts suggested that markets had not yet fully priced in the risk of escalating trade tensions. BBVA’s Alejandro Cuadrado noted that tariffs would likely remain a dominant market theme in the coming months.
“Tariffs will continue to dominate the markets, and some traders still believe they could be reversed. The full impact may not yet be priced into FX markets”, he wrote on Monday.
ING’s Francesco Pesole warned that the prospect of a global trade war, with tariffs extending to the EU, represented a clear downside risk for the euro.
He added that “the potential for a major US trade report in April could keep investors in a sell-the-rally mindset for EUR/USD”.
Luca Cigognini, a market strategist at Intesa Sanpaolo, highlighted 1.0180 as a key technical support level for the euro, warning that, if breached, the currency could fall towards 1.0120.
European stocks slump, auto sector hit hardest
European equity markets fell sharply as trade concerns overshadowed inflation data. The Euro STOXX 50 dropped 1.9%, while Germany’s DAX index slid 2%.
The car sector faced the steepest losses, as fears of US tariffs on European cars rattled investors. Volkswagen shares fell by more than 6%, Mercedes-Benz declined 4.9%, and BMW lost 4.5%. In Milan trading, Stellantis dropped over 7%, while tyre manufacturer Pirelli saw its stock fall by 5.5%.
The uncertainty surrounding trade policy and its potential economic impact led investors to seek refuge in sovereign bonds, pushing yields lower across Europe. German Bund yields fell by eight basis points to 2.40%, while France’s OAT yields declined by six basis points to 3.15%.