Inflation in the Eurozone decreases below the ECB's target rate, fueling speculation about potential rate cuts.
Revised Article:
Inflation in the eurozone chilled below the European Central Bank's (ECB) goals last month, leaning the cards for further monetary easing––despite external pressures stoking long-term price pressures.
Consumer prices across the 20 euro-adopting countries slid to 1.9% in May, dropping from 2.2% the previous month. This drop surpassed predictions for a 2.0% figure, steered by a dip in energy costs and a significant slump in services inflation.
dig deeper: ECB's Eye on Headwinds and Tailwinds
The ECB's preferred gauge of underlying inflation, excluding volatile fuel and food prices, meanwhile fell to 2.3% from 2.7%. This dip was propelled by decelerating services price growth, sinking from 4.0% to 3.2%.
The ECB has slashed interest rates seven times since June 2024, setting the stage for another rate reduction on Thursday. These predictions come as a result of low wage growth, easing energy prices, a strong euro, and sluggish economic growth––all which suggest a direction of easing inflation.
Riccardo Marcelli Fabiani at Oxford Economics expressed optimism about the ECB lowering rates, stating, "Given the clear disinflationary outlook, especially for services, the ECB cutting rates this Thursday seems an easy bet, and more easing should follow later in the year."
If economists are right, inflation could fall below the ECB's 2% target in 2025 and not recover until 2026. Bert Colijn from ING speculated that the ECB could be confronted with a problem of weak inflation causing a dip in expectations for longer-term prices.
This conundrum for the ECB arises due to the contrast between short-term and longer-term inflation perspectives. While inflation might face upward pressure from various factors further out, the ECB is poised to pause rate cuts after potentially easing to 2% in June and make only one more cut this year, perhaps in the autumn.
However, investors recognize a roughly 30% chance of an additional rate cut in autumn, bringing the deposit rate to 1.5%. Interest rates are now firmly entrenched in neutral territory, neither stimulating nor slowing economic growth, making some analysts reluctant to make any significant policy moves.
Warnings from policy hawks about inflation rebounding intensify as geopolitical tensions and increased tariffs cause price escalation. Factors such as a trade war, deglobalization, realignment of corporate value chains, declines in the working-age population, and investments in defense and climate change are all potential culprits.
As these contrasting trends unfold, the ECB must weigh its response. Though it typically overlooks short-term price volatility, it may need to intervene if it believes that a temporary price dip is leading to a decline in longer-term expectations.
- The ECB's monetary policy decisions are heavily influenced by the state of the business and finance sectors, as they consider factors such as low wage growth, easing energy prices, and sluggish economic growth when deciding on interest rates.
- Even though geopolitical tensions and increased tariffs could potentially cause price escalation in the long term for various sectors of business and finance, the ECB may choose to pause rate cuts and make only one more cut this year, given that inflation is currently below their 2% target and there is a rough 30% chance of an additional rate cut in autumn.
