Euro Zone Inflation Drops Below 2%

By Balazs Koranyi
FRANKFURT (Reuters) – Euro zone inflation dipped below 2% for the first time since mid-2021 in September, reinforcing a strong case for a European Central Bank (ECB) rate cut this month as the battle to control inflation nears its end.

Inflation in the 20 euro currency-sharing countries eased to 1.8% in September from 2.2% in August, according to Eurostat data released on Tuesday, falling below expectations of 1.9% as a result of decreased energy costs and stable goods prices.

Core inflation, a key indicator of underlying prices, declined to 2.7% from 2.8% amid slower services price growth, also below the anticipated 2.8%.

For years, inflation has exceeded the central bank’s target due to rising energy costs, production issues during the post-pandemic recovery, corporate price strategies, and extensive fiscal support, peaking at over 10% by late 2022.

However, a series of interest rate hikes from the central bank has stabilized price growth, leading policymakers to consider how quickly to reduce borrowing costs.

After rate reductions in June and September, ECB President Christine Lagarde hinted at another possible cut this month based on improving price trends.

This anticipated quick follow-up was not expected recently, but disappointing growth data, easing wage pressures, and inflation figures below ECB forecasts have heightened the urgency.

Supporting the case for a rate cut, services inflation eased slightly to 4.0% from 4.1%, allaying but not eliminating concerns about persistent domestic price pressures.

Wage growth has historically influenced services costs; however, economists foresee a slowdown due to softening labor markets, subdued growth, and minimal wage increases.

Falling energy costs were the primary driver of disinflation, while non-energy industrial goods prices only rose 0.4% year-on-year, further lowering the overall inflation figure.

Lagarde indicated that inflation is now below the ECB’s projected baseline, challenging the ECB’s outlook on sustained price pressures and the return to the 2% target likely by the end of 2025.

Following Lagarde’s remarks, investors increased their expectations for quicker rate cuts, with markets showing an 85% chance for a cut on October 17, up from 25% at the week’s start.

They also forecast over 50 basis points of adjustments by year-end, indicating that back-to-back cuts are likely.

Consequently, bank economists have revised their expectations, with most major banks now predicting cuts in October, December, and possibly January.

The ECB anticipates inflation will rise slightly above 2.5% around year-end, but declining oil prices pose downside risks to this projection, leading investors to see a significant possibility that the ECB will fall short of its target.