Eurozone inflation drops to 2.2% and closes in on ECB target

Eurozone inflation dropped to 2.2% in August, its lowest level since mid-2021, closing in on the European Central Bank’s (ECB) 2% target.

This decline in inflation across the 20 EU countries using the euro fuelled expectations that the ECB may opt for a second interest rate cut this year, as concerns grow over the faltering economic recovery in the region.

Consumer prices in the eurozone were 2.2% higher in August compared to the same period last year, down from 2.6% in July, according to data from Eurostat, the EU’s statistics agency.

This marks the lowest inflation rate since July 2021. A 3% drop in energy prices significantly contributed to the overall decline, with inflation in Germany—the eurozone’s largest economy—falling to 2%.

Core inflation, which excludes volatile food and energy costs, eased to 2.8% from 2.9% a month earlier, in line with expectations, as muted imported goods prices offset a rise in services inflation to 4.2% from 4%.

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Services prices were likely inflated by the Olympic Games in Paris, as the cost of services in France surged sharply — a rise that some economists believe will be a one-off, temporary effect.

Economists now anticipate that the ECB will reduce its key interest rate by a quarter of a percentage point from the current 3.75% at its upcoming meeting on 12 September. This would follow the ECB’s first rate cut in June — its first since 2019 — as inflation began to ease from its peak of over 10% in late 2022.

Meanwhile, the US Federal Reserve is also expected to lower rates from their 23-year high of 5.25%-5.5% at its policy meeting scheduled for 17-18 September.

ECB chief economist Philip Lane signalled this month that further rate reductions were likely in Europe. He warned that keeping interest rates “too high for too long would deliver chronically below-target inflation over the medium term”, while warning that a return to the ECB’s 2% target was not yet certain.

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Despite the positive headline figures, ECB board member Isabel Schnabel urged caution. Speaking at a conference in Estonia on Friday, she said that the apparent easing of inflation might obscure the deeper challenges still confronting monetary policymakers.

"The current level of headline inflation understates the challenges monetary policy is facing," Schnabel said, highlighting the complex economic landscape the ECB must navigate in the coming months.

Sam Miley, managing economist and forecasting lead at the Centre for Business and Economics Research, said: "Eurozone inflation slowed to 2.2% in August from 2.6% in July, driven by energy price declines. This marked the slowest rate of price growth for more than three years and makes a rate cut at the European Central Bank’s upcoming September policy meeting more likely.

"However, the higher rate of core inflation and continually tight labour market will present risk factors to implementing looser monetary policy."

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