Eurozone inflation forecast: What to expect from…?

core inflation, which shows prices excluding energy and food costs, is likely to have fallen slightly year-on-year from 2.9% in July to 2.8%.

“Investors will be pleased to hear that the rise in inflation that we Witness in July should decrease again in AugustEconomists have a headline of only 2.2%, a 40 Base Point fall than last month, and a number much closer to the European Central Bank target level,” said Michael Field, European market strategist at Morningstar, adding that estimated data for Core inflation”remains significantly higher than the targeted inflation rate of 2%; but at least it is going in the right direction.”

In July 2024, services (+1.82 percentage points, pp) made the largest contribution to euro area annual inflation (HICP), followed by food, alcohol and tobacco (+0.45 pp), non-energy industrial goods (+0.19 pp) and energy (+0.12 pp).

According to Tomasz Wieladek, chief European economist at T. Rowe Price, the likely decline in euro area headline HICP inflation to 2.2% in August is mainly due to falling energy prices in August 2024 compared with August 2023, so-called “base effects”.

Wieladek expects core HICP inflation to remain at 2.9% in August. “HICP services inflation, the most reliable measure of underlying inflation, is likely to remain at 4%. Part of the strength in services inflation in August can probably be explained by one-off price effects related to the Olympic Games in France. However, services inflation remains well above levels consistent with the ECB's target,” he told Morningstar.

Core inflation, the indicator that excludes volatile components such as fuel and food, is also expected to fall.by 10 basis points to 2.8%.

What inflation expectations do investors have?

In August, the indicator of long-term inflation expectations reached its lowest level in almost two years, according to the Financial Times.

The five-year forward inflation swap, which measures the expected inflation rate for the five-year period beginning in five years, fell below 2.1% last week for the first time since October 2022.

In the minutes of the July meeting, published on 22 August, the ECB said that “incoming information and forward-looking indicators generally confirmed the Governing Council's previous assessment of the medium-term inflation outlook”. Headline inflation is expected to fluctuate around current levels for the rest of the year, decline to the target level in the second half of next year and then stabilise around the target level in 2026.

According to the ECB minutes, core inflation was higher than expected and “risks remain on the upside given repeated positive surprises in services inflation.”

Will the ECB lower interest rates in September?

The next monetary policy meeting of the ECB will take place on September 12 in Frankfurt and economists largely expect an interest rate cut.

According to the ECB minutes, ECB officials went into the meeting with an “open mind” regarding interest rate cuts. “The September meeting was generally seen as a good time to reassess the extent of monetary policy constraints,” the minutes say. Data dependence does not mean “overly focusing on specific, individual data points.”

According to Morningstar’s Field, “with inflation seemingly calm there or approximately where we need it, and unemployment remain stable, the ECB should be confirmed in its course. This means we are well positioned for further interest rate cuts this year.”

Wieladek said: “Although inflation dynamics in the services sector have declined from the strong levels of the first half of the year, they are still too strong and too sluggish. However, inflation is clearly not the only relevant data point for monetary policy. Collective wage growth in the second quarter of 2024 has fallen significantly. Business surveys underline the risk that the economy could weaken more than expected.”

Wieladek expects the ECB to cut its key interest rates again by 25 basis points in September. “As the euro area recovers from the large supply shock caused by high energy prices, this stagflationary picture of sluggish inflation and weak economic activity is likely to persist for some time,” he added. “For this reason, I believe that after September 2024 the ECB will only cut at a quarterly pace and will probably end the cut at a deposit rate of 2.5%.”