Eurozone inflation fell this month to its lowest since June 2021, adding to the case for the European Central Bank (ECB) to cut interest rates in September.
Inflation in the single currency bloc dropped to 2.2% in August, down from 2.6% in July, and barely above the ECB’s 2% target.
The ECB, led by Christine Lagarde, is weighing up whether to cut interest rates at its next meeting on 12 September. In June it cut its main interest rate from 4% to 3.75%, the first downwards move since 2019.
Central bankers around the world are trying to engineer “soft landings” – bringing inflation below target while avoiding recession. The Federal Reserve chair, Jerome Powell, last week said “the time has come” for lower interest rates in the US, although the Bank of England governor, Andrew Bailey, has warned he is hesitant to cut rates too quickly.
The expected round of interest rate cuts comes as the bout of price increases during the chaos of the Covid pandemic has faded. Supply chains were disrupted by pandemic lockdowns, leading to steep price rises, before Russia’s full-scale invasion of Ukraine caused global energy prices to soar.
In August it was falling energy inflation that had the biggest effect on dragging Europe’s harmonised index of consumer prices down, according to Eurostat, the EU’s data agency.
Core inflation, which strips out the more volatile components including energy prices, dropped slightly from 2.9 to 2.8%, but services inflation ticked up from 4% to 4.2% as hosting the Olympic Games in Paris pushed up French services prices.
Bert Colijn, a senior economist for the eurozone at Dutch investment bank ING, said he did not expect core inflation to drop below 2.5% for the rest of the year.
“The ECB has arrived on a long home straight when it comes to bringing inflation back to target,” Colijn said. He added that the modest decline in inflationary pressures and expectations for slowing inflation next year should be enough to persuade the ECB to cut rates in September.
However, he also said: “This remains a slow and gradual process of releasing the brakes on the economy as the ECB continues to be concerned about upside risks to the inflation outlook.”
Eurozone unemployment also edged down unexpectedly from 6.5% to 6.4%. Central bankers tend to be wary of cutting interest rates when unemployment is falling because it can be a sign of shortages of workers that could lead to inflationary pressures building.
Transactions on financial markets on Friday implied that a cut to the ECB’s main interest rate of 0.25 percentage points is a near certainty, with two more expected before the end of the year.
Sam Miley, the forecasting lead at the Centre for Business and Economics Research, warned that “the higher rate of core inflation and continually tight labour market will present risk factors to implementing looser monetary policy”.
