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There is growing uncertainty over whether the European Central Bank will cut interest rates in September, after inflation in the euro zone rose slightly to 2.6% in the year to July.
The latest euro zone inflation rate released on Wednesday beat last month’s 2.5% rise and exceeded economists polled by Reuters who expected price pressures to remain flat.
Significant increases in energy prices and higher commodity prices led to higher inflation across the 20 countries that share the euro.
Economists at Dutch bank ING said the figures made the possibility of a rate cut at the next interest rate meeting in September “extremely critical.”
A slowdown in upward price pressures in key service sectors (the part of the economy that many rate setters are most concerned about) is enough to persuade support for a further quarter-point cut in the benchmark deposit rate (currently 3.75%). Some believe it can be a force. .
Franziska Palmas, an economist at Capital Economics, said: “The modest decline in services inflation in July means that the September rate cut is probably enough to maintain the base case,” adding that August’s inflation rate declines. He added that the decision could be influenced by whether the market would continue to rise or continue to rise.
Markets still think the central bank is likely to cut rates in September, with swap pricing suggesting there is a 65% chance borrowing costs will fall. Tuesday’s pricing was little changed, but the probability is down from 80% a few weeks ago.
Yields on two-year German government bonds, which are sensitive to interest rates, fell slightly the day after the inflation data, dropping 0.02 percentage points to 2.54%. The movement in yields that is inversely proportional to prices suggests that investors still expect multiple rate cuts from policymakers.
The ECB became more confident that inflation would fall to its 2% target by next year and was the first major central bank to begin cutting interest rates in June, but this month it kept them on hold.
Rate setters say inflation will be “volatile” for much of this year. Some policymakers remain concerned that service prices could continue to rise sharply and overall inflation could remain high.
However, growth in service prices slowed by 0.1 percentage point to 4% in July, according to EU statistics agency Eurostat, which publishes this data.
A series of major sporting and cultural events and the start of the summer tourist season were expected to drive up prices for many services in high demand in Europe, such as hotel rooms and airline tickets.
Frédéric Decrozet, an economist at Pictet Wealth Management, said the rise in inflation in July “is not really a cause for concern, but the ECB will remain cautious.”
Energy inflation accelerated to 1.3% in July from 0.2% in June. Price growth for food, alcohol and tobacco slowed to 2.3%, but prices for other goods rebounded slightly, rising 0.8%.
The closely watched measure of core inflation, which excludes energy and food, was left unchanged at 2.9% to give policymakers a better picture of underlying price pressures.
Economists had expected core inflation to slow slightly. But Tomasz Wiladek, an economist at investment firm T. Rowe Price, said the rise in numbers was due to higher container shipping costs, which pushed up commodity inflation.
Mr Wierardek said the ECB was unlikely to worry too much about this as the futures market betting on shipping costs showed that it was “likely to be temporary”.
In June, the ECB predicted that inflation would reach its 2% target by next year and cut its benchmark deposit rate from a record high of 4%.
When the ECB left interest rates on hold two weeks ago, President Christine Lagarde said there was still “considerable room” for the next decision in September and that it would depend on how the data develops.
“The persistence of services inflation shows that the ‘last mile’ of the fight against inflation is particularly difficult,” ECB board member Isabel Schnabel said last week. But he added in an interview with Frankfurter Allgemeine Zeitung that next year’s inflation rate is still expected to “gradually converge” to the target.
