Euro Zone Inflation Drops Below 2%, Strengthening Case for Rate Cuts – Reuters

By Balazs Koranyi

FRANKFURT – Euro zone inflation fell below 2% for the first time since mid-2021 in September, strengthening the case for a European Central Bank (ECB) rate cut this month as efforts to control soaring prices are nearing their conclusion.

Inflation across the 20 countries using the euro dropped to 1.8% in September from 2.2% in August, according to Eurostat data released on Tuesday. This was below the anticipated 1.9% outlined in a Reuters poll, primarily driven by declining energy costs and subdued prices for goods.

Core inflation, a closely monitored metric reflecting underlying price trends, decreased to 2.7% from 2.8%, also falling short of expectations for 2.8%.

For years, price growth has exceeded the central bank’s target due to rising energy costs, production issues following the pandemic, corporate pricing strategies, and substantial fiscal support, which pushed inflation rates above 10% by late 2022.

However, a record series of interest rate hikes by the central bank has effectively managed to rein in price growth, prompting discussions among policymakers about the pace at which they should lower borrowing costs.

The ECB has already cut rates in June and September, and ECB President Christine Lagarde recently indicated that another cut might occur later this month in light of favorable price trends.

While a quick follow-up rate cut was not anticipated until recently, poor growth data, easing wage pressures, and inflation readings falling below the ECB’s own forecasts have added pressure for action.

Services inflation, a key component of overall price growth, eased slightly to 4.0% from 4.1%, alleviating some concerns about persistent domestic price pressures. Nevertheless, rapid wage growth has historically driven up service costs, although a slowdown is expected due to softer labor markets, weak growth, and smaller pay increases.

Declining energy prices have been the primary driver of disinflation, while non-energy industrial goods prices rose just 0.4% compared to last year, further lowering the overall inflation rate.

Lagarde has noted that inflation is now below the ECB’s predicted baseline, challenging the bank’s narrative about sustained price pressures and the timeline for reaching the 2% target, which is now projected for late 2025.

Following Lagarde’s comments, investors increased their expectations for quicker rate cuts, with markets now pricing in an 85% probability of a rate cut on October 17, up from 25% at the beginning of the previous week.

Investors are also anticipating over 50 basis points of rate adjustments by the end of the year, indicating that consecutive cuts are fully expected.

This shift has prompted numerous bank economists to revise their forecasts, with most major banks now predicting rate cuts in both October and December, and potentially January as well.

The ECB has forecast a rise in price growth above 2.5% around the turn of the year, yet sharply declining oil prices suggest potential downside risks to this forecast, leading investors to believe the ECB may fall short of its target.