Eurozone inflation rose to 2.6% in May

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Eurozone inflation rose for the first time this year, adding to concerns about how slowly the European Central Bank will cut interest rates if price pressures remain high.

The 2.6 percent rise in consumer prices in the single currency area in the year to May was up from 2.4 percent in the previous month and slightly above the level forecast by economists in a Reuters poll.

Core inflation – which excludes energy and food to give a sense of underlying price pressures – accelerated from 2.7% to 2.9%, a worrying sign for investors who hope the ECB will cut interest rates aggressively this year year.

Until this month, eurozone inflation had slipped slightly below the ECB’s 2 percent target for the year, allowing policymakers to signal clearly that they expect to start cutting their benchmark deposit rate from its record high of 4 percent next week.

The yield on Germany’s 10-year bond – a benchmark for borrowing costs in the eurozone – jumped to 2.7 percent in response to Friday’s data, the highest level in more than six months.

Line chart of the Harmonized Index of Consumer Prices (annual percentage change), showing that euro area inflation remains above the ECB's target

The ECB is still expected to continue cutting interest rates next week – making it the first major central bank to ease monetary policy since the biggest jump in inflation in a generation three years ago.

But with price pressures intensifying again this month and the eurozone economy returning to growth in the first quarter, investors expect the ECB to take a more cautious approach to cutting interest rates by the end of this year.

Jack Allen-Reynolds, an economist at Capital Economics, said the surge in eurozone inflation “will not prevent the ECB from cutting interest rates next week. But another cut in July looks unlikely.”

The ECB’s chief economist, Philip Lane, told the Financial Times earlier this month that “barring any major surprises”, the central bank was likely to lift the highest level of restraint at its meeting next week in Frankfurt.

He said the pace of further cuts would depend on the path of core inflation and the level of demand, which he warned was likely to be “uneven and gradual”.

Some policymakers have warned that higher inflation will make it less likely that the ECB will cut in July. Markets estimate between two and three rate cuts of 0.25 percentage points this year.

The ECB expects wage growth in the euro zone to slow from recent record highs and for companies to absorb higher labor costs by cutting profit margins rather than passing them on to consumers through price hikes.

This will be critical in determining how quickly inflation in the labor-intensive services sector will decline this year. Eurozone services inflation rose to a seven-month high of 4.1 percent in May from 3.7 percent a month earlier.

Still, some economists see one-off factors behind the recent uptick in services inflation, including this year’s earlier timing of Easter – which usually causes higher prices in April to fall in May – and the fading disinflationary impact of discounted public transport fares in Germany, which were released a year ago.

“The rise in service price inflation is not welcome,” said Diego Iscaro, an economist at S&P Global, adding that he would wait for detailed data to show “whether the end of German transport subsidies is the main culprit or there are other factors raising the prices of services”.

There are signs that consumers remain cautious, although their purchasing power has been boosted by wages rising faster than inflation this year. Retail sales in Germany fell 1.2 percent in April from a month earlier, separate data showed on Friday, while retail sales in France fell 0.8 percent over the same period.

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