12 January 2026 — Europe’s Quiet Victory: Inflation Falls but New Risks Rise

Last Wednesday, the European Union’s statistical office published what ought to have been a celebratory number. Annual inflation in the eurozone had fallen to 2.0% in December, landing precisely on the ECB’s target for the first time in five years.¹ Five years ago, it touched 10.6%. And yet markets responded to the milestone with a shrug. The German DAX continued its rally to a new record high. The euro barely moved.²

The bigger story — and why the DAX keeps setting records — is that for the first time in well over a decade, European equities are outperforming American ones. Partly because European shares entered last year at historically cheap valuations. Partly because Germany, under a new government formed after its February 2025 elections, announced a vast fiscal package for defence and infrastructure, easing the constitutional limits on public spending. Siemens shares alone more than doubled between early 2024 and the end of last year.

The U.S. tariff shock last April has paradoxically helped Europe. Global investors heavily overweight American assets re-examined their holdings after Liberation Day. Capital that once flowed automatically into U.S. Treasuries and U.S. tech has sought alternatives. Some has gone to gold. Some to China. A great deal has gone to European equities — particularly German ones.

The ECB cut rates four times in the first half of last year before leaving them unchanged. Its main rate stands at 2.15%.¹ Lagarde has described the stance as “in a good place” and said the ECB will remain “data-dependent.” This reflects an awkward new problem. With inflation at 2.0% and expected to fall further, pure logic says cut. But unemployment at 6.1% is a historical low, and growth at 1.4% is reasonable. Cutting risks reigniting the inflation the ECB spent years subduing.

The less obvious risk is external. Chinese overcapacity in electric vehicles, steel and solar panels, combined with U.S. tariffs closing off the American market, is pushing Chinese exporters to Europe. Good news for consumers; a direct threat to European producers; a policy headache for the ECB. Joerg Held of Ethenea told Morningstar: “We import deflation via the strong euro. The ECB is keeping a very close eye on this, but we are still a long way from the point at which it would need to take countermeasures.”³

For European savers, the start of 2026 looks deceptively benign. Shares are up. Bonds are finally yielding something. But three points are worth holding. The end of the inflation war does not mean the end of drama. Europe’s strength rests on assumptions — a stable U.S. relationship and manageable Chinese flows — that are not guaranteed. And the reward for being diversified has finally shown up: investors who stayed the course through 2022–23, resisting the temptation to concentrate in U.S. tech, are being rewarded.