In May, inflation in the euro zone rose to 2.6%, exceeding economists’ expectations of a 0.1 percentage point increase from April’s figure of 2.4%. Core inflation, which excludes volatile components such as energy, food, alcohol, and tobacco, also saw an increase to 2.9% from 2.7% in April. Despite the higher than expected inflation figures, market expectations of an interest rate cut from the European Central Bank (ECB) next week remain unchanged. The ECB is widely expected to cut interest rates at its upcoming meeting on June 6, which would be the first reduction since 2019.
The ECB has been signaling for weeks that a 25 basis point cut is likely at the upcoming meeting. Any deviation from this expectation would come as a major surprise to markets. Money markets are currently pricing in a cut in June followed by one more reduction in 2024. While headline inflation has been fluctuating, it has remained below 3% for the past eight months. The upcoming meeting will also provide more insights into the pace and level of potential cuts this year, as the staff releases their latest inflation and growth projections.
While the headline figure of inflation in the euro zone has cooled significantly from its peak in 2022, ECB members are closely monitoring services inflation, which rose to 4.1% from 3.7%. This increase in services inflation is seen as a key indicator of domestic inflationary pressures. ECB voting member Klaas Knot has emphasized the need for a gradual easing of monetary policy to prevent inflation expectations from becoming unanchored from forecasts. Analysts believe that the recent inflation print is likely just a temporary bump in the disinflationary trend, rather than a significant shift in the overall trajectory.
Despite the slight increase in inflation in May, hopes for a rate cut in July have diminished. If the ECB decides to lower rates in June, it would be a result of the momentum building up for a cut over the past nine months. The euro strengthened slightly against the U.S. dollar and British pound following the inflation data release. The current economic environment in the euro zone, marked by uncertainty around inflation and monetary policy, has kept markets on edge. The upcoming ECB meeting will provide more clarity on the central bank’s stance and future policy actions.
