Eurozone inflation expectations have significantly fallen, with market bets on interest rate hikes cooling down.

The latest monthly survey published by the European Central Bank (ECB) on Friday showed that euro area consumers' inflation expectations for the next 12 months significantly fell in May, and this change occurred before the United States and Iran reached a lasting peace agreement. The survey data showed that consumers expect a 3.5% increase in prices in the next year, a significant decrease from April's 4%. The three-year and five-year inflation expectations, which are more relevant for monetary policy formulation, remained high at 2.9% and 2.4% respectively. The survey was conducted from May 7 to June 1, when the United States and Iran had not yet taken substantial steps towards a lasting peace agreement. Since then, the warming ceasefire expectations have pushed oil prices back to pre-war levels, prompting economists and investors to lower their bets on further rate hikes by the European Central Bank. The European Central Bank raised borrowing costs earlier this month for the first time since 2023, and did not rule out the possibility of further rate hikes. Policymakers warned that inflation pressures are spreading beyond the initial surge in energy prices, showing a more widespread upward trend. The intensification of core inflation pressures in May provided evidence for this assessment. Isabel Schnabel, a member of the ECB's Executive Board, stated this week that more action is needed under the current circumstances to bring inflation back to the target level of 2%. In contrast, President Christine Lagarde and Chief Economist Philip Lane expressed a more cautious stance in their concerns about the economic outlook of the euro area. Lagarde previously warned that high energy prices are beginning to transmit to other areas of the economy, and the risk of "second-round effects" of inflation has emerged. However, she also stated last week that given anchored inflation expectations and a return to the target in the medium term, there is no need to take stronger action in response to the Middle East conflict. Lane also believed that even if peace is maintained in the Middle East, euro area inflation will remain above the 2% target for a period of time, but this shock only requires "prudent policy responses". Recent inflation data supports the hawkish stance. Eurostat data showed that the final value of the euro area's CPI in May was 3.2%. More concerning is the core inflation indicator - the core CPI, excluding energy, food, and tobacco prices, rose to 2.6% in May, up from 2.2% in April. Energy prices increased by 10.8% year-on-year, contributing 0.98 percentage points to inflation; service prices rose by 3.5% year-on-year, contributing 1.61 percentage points, the main driver. The accelerating upward trend in core inflation implies that price pressures are gradually spreading to a broader economic domain. The survey also showed that respondents expected a 1.7% contraction in euro area GDP for the next 12 months, narrowing from the 2.2% contraction forecast in April. Expectations for unemployment rate a year later rose slightly to 11.3%. Consumer expectations for housing price increases fell from 3.7% in April to 3.6%, with the average housing price increase expectation for the lowest income group at 4.1%, significantly higher than the 3.4% for the highest income group.