Inflation in the 20 European Union countries that use the euro dropped to 2.2% in August, down from 2.6% in July, as reported by the European Union statistics agency Eurostat. This decline has created an opportunity for the European Central Bank to consider cutting interest rates, aligning with the U.S. Federal Reserve's plans to lower borrowing costs to stimulate growth and employment.
The decrease in inflation was primarily driven by a 3% fall in energy prices, contributing to an overall inflation rate of 2% in Germany, the largest economy in the eurozone. This figure is now in proximity to the ECB's target of 2%, which is deemed optimal for the economy's stability.
Economists anticipate that the ECB may reduce its key rate by a quarter point from 3.75% at its upcoming meeting on September 12, while the Fed is expected to lower rates from a 23-year high of 5.25%-5.5% during its policy meeting on September 17-18.
The recent decline in German inflation has tilted the scales towards a potential rate cut in September, according to experts. The combination of diminishing inflationary pressures and waning growth momentum presents a favorable macroeconomic environment for another rate adjustment.
Despite the positive outlook, economists warn that the path to reaching the 2% target could encounter obstacles. The ECB foresees fluctuations in inflation going forward but anticipates achieving its target by the end of the following year.
Central banks had previously raised interest rates significantly to combat inflation triggered by factors such as energy price spikes following geopolitical events and supply chain disruptions due to the post-COVID-19 economic recovery. The current decrease in inflation marks a substantial decline from the 10.6% peak observed in October 2022.
While high rates can help curb inflation by increasing the cost of borrowing and spending, thereby reducing demand and alleviating price pressures, they can also impede economic growth. Concerns about the adverse effects of elevated rates on employment and economic activity have prompted central banks in Europe and the U.S. to consider rate adjustments.
The eurozone's modest 0.3% growth in the second quarter reflects the impact of high rates on various sectors, including housing markets, consumer and business loans, and renewable energy projects. Central bankers emphasize the importance of striking a balance between controlling inflation and supporting economic activity to prevent long-term negative consequences.
While the ECB remains cautious about the economic outlook, ECB head Christine Lagarde has emphasized that rate decisions will be based on real-time economic data. The ECB initiated a rate cut in June and has been assessing the need for further adjustments, with a focus on achieving the 2% inflation target in the future.
