Euro Zone Core Inflation Rises, Rate Cut Still Expected
By Balazs Koranyi
FRANKFURT (Reuters) -Euro zone prices rose more than expected last month and underlying price pressures accelerated, an unwelcome trend that is still not expected to prevent another interest rate cut to insulate the economy from the fallout of a global trade war.
Inflation in the 20 nations sharing the euro currency held at 2.2%, coming above expectations for 2.1% in a Reuters poll of economists as the price growth in services and unprocessed foods offset the dip in energy costs.
A surge in services prices pushed up underlying or core inflation, which excludes volatile food and energy prices, to 2.7% from 2.4%, above expectations for 2.5% suggesting that domestic price pressures are higher than thought.
While ECB policymakers normally place great emphasis on inflation prints - especially the uptick in core prices - the U.S. administration's trade war with the rest of the world may be far important in the run up to the bank's June 5 policy meeting.
"The high level of uncertainty around the global and euro area growth outlook implies that the ECB may not pay much attention to the higher than expected April inflation numbers at its June meeting," Nordea economists said in a note.
Indeed, financial investors continue to see about an 85% chance of a rate cut on June 5 and then at least one more move before the end of the year, which would take the ECB's deposit rate to 1.75% or lower.
Still, the big rise in services prices is likely to bolster calls by policy hawks to slow the pace of policy easing before there is decisive evidence that the target is reached.
Policymakers speaking on and off the record have also started to pave the way for the ECB's eighth rate cut in 13 months as the trade war's will weigh on prices and could even drag inflation below target.
Indeed, the bank's communication has already shifted. While the ECB earlier saw inflation back at target only in 2026, policymakers now say that the target has essentially been achieved.
This is because trade strife slows economic growth and curbs investment, and it has already pushed down energy prices and strengthened the euro, making imports cheaper. Moreover, many fear that China could start dumping its surplus products on Europe given its limited access to the U.S.
"Today's increase in the core component does not change the outlook, which has become more disinflationary," Riccardo Marcelli Fabiani at Oxford Economics said.
"Turmoil in financial markets amidst growth concerns has led to a significant drop in international oil prices, which will not only drag down energy inflation but also mean cheaper inputs for goods production," he said.
While a more fragmented world economy could ultimately increase production costs, this upside risk is seen as rather limited and investors' longer-term inflation expectations are holding firm around the ECB's 2% target.
More spending on defence could also boost prices since that is bound to increase budget deficits, but any such spending is still well into the future and may only have a limited impact on prices, economists says.
(Reporting by Balazs Koranyi; Editing by Hugh Lawson)
