European stock markets experienced a strong rally following cooling inflation data from the UK and the US on Wednesday. However, the weakness in the euro and the pound sterling may persist due to the ongoing economic and political uncertainties.
European stock markets recorded their best day since August on Wednesday after CPI data from the US and UK signalled cooling inflation. The Euro Stoxx 600 Index ended a three-day losing streak, climbing 1.33% – its largest one-day rally in nearly five months.
Risk-on drives the broad rally
Risk-on sentiment prevailed in the global markets as cooling inflation further enhanced bets for continued rate cuts by central banks.
Germany’s benchmark, the DAX rose 1.5%, reaching a new record high. The index outperformed global major averages, gaining 3.34% this year. The rally may have been driven by expectations for the ECB to implement more aggressive rate cuts compared with other central banks, despite domestic economic and political challenges.
The FTSE 100 advanced 1.21%, recovering from last week’s British bond turmoil, while France’s CAC 40 gained 0.69%, continuing to lag its peers.
However, the euro pared early week gains against the US dollar, with the euro-dollar pair slightly weakening to 1.0288 as of the early Thursday Asian session. The common currency has also retreated against the pound sterling after hitting a nearly five-month high last week.
Wall Street also experienced a strong rally, particularly in the technology shares. Robust big US bank earnings from JP Morgan Chase, Citigroup, Wells Fargo, and Goldman Sachs, have further supported the upside momentum.
Inflation on a cooling trajectory globally
Inflation from both sides of the Atlantic showed signs of cooling. In the US, core inflation (excluding volatile items like food and energy) fell to 3.2% year-on-year in December, down from 3.3% in November, although headline inflation remained slightly elevated.
That followed cooler-than-expected producer price index (PPI) data on Tuesday, increasing the likelihood of continued Federal Reserve rate cuts in 2025. Market participants viewed the December inflation reading as critical for shaping sentiment.
Prior to the release, concerns lingered that sticky inflation and resilient labour markets might prompt the Fed to pause its rate-cut cycle, although the Fed is widely expected to pause its rate cut at its upcoming meeting later this month.
Eurozone inflation data due on Friday
The eurozone is set to release the final inflation data for December on Friday. The flash data from last week showed that core inflation remained at 2.7% for the third consecutive month, while headline consumer price ticked up to 2.4% from 2.2% in the previous month.
Both data have met expectations, further strengthening bets for a 25 basis point rate cut by the European Central Bank in January. Despite the recent rebound in the euro, the policy contrast between the Fed and ECB is likely to continue putting pressure on the common currency against the dollar.
In the UK, the headline inflation and the core consumer prices in December came at 2.5% and 3.2%, compared with the expected 2.6% and 3.4% respectively. This marks the first decline in inflation in three months, supporting expectations that the Bank of England will continue its easing cycle.
The data provided some relief to investors following recent turmoil in British markets. Following the release, the 10-year gilt yield fell 16 basis points to 4.73%, retreating from last week’s more than decade-high of 4.9%. The pound briefly rebounded to a one-week high before paring some gains.
However, this relief could be temporary.
“These gains, however, seem set to prove relatively short-lived, as concerns over the UK’s fragile fiscal backdrop, and Chancellor Reeves’s lack of fiscal headroom, persist, resulting in a higher risk premium continuing to be priced into UK assets,” Michael Brown, a senior research strategist at Pepperstone London, wrote in a note.
