European inflation falls but sticky services costs raise doubts for ECB

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Inflation in the eurozone’s two largest economies has fallen to its lowest level since mid-2021, but services prices remain stubbornly strong, presenting the European Central Bank with a conundrum over when to cut interest rates.

Both Germany and France benefited from weaker inflation in goods and food in February, but this was partly offset by a rebound in energy costs and persistent growth in services prices. In Spain, electricity prices slowed but fuel costs accelerated.

Since the disruption of the coronavirus pandemic and Russia’s invasion of Ukraine triggered the biggest surge in consumer prices for a generation, eurozone inflation has been slowing rapidly, leaving ECB policymakers trying to gauge how fast it will drop to their 2 per cent target.

The ECB is expected to cut its forecasts for inflation and growth when it meets next week in Frankfurt. But most economists believe it will keep saying it needs more evidence to be sure rising wages are not causing price pressures to flare up before it will lower borrowing costs.

German inflation was 2.7 per cent in the year to February, the federal statistical agency said on Thursday, in line with economists’ forecasts in a Reuters poll and down from 3.1 per cent in January.

However, rapid wage growth kept services prices rising at a steady rate of 3.4 per cent in Europe’s largest economy. Core inflation, excluding volatile energy and food prices, also kept rising at the same pace.

Carsten Brzeski, an economist at Dutch bank ING, said the persistence of underlying German price pressures — particularly for services — “illustrates just how difficult the last mile will be for the ECB and clearly argues against cutting rates too early”.

German wages rose 6 per cent last year, outstripping the 5.9 per cent average rate of inflation for the first time since the pandemic hit four years ago. However, consumers remained cautious at the start of this year, after retail sales fell 0.4 per cent in January from the previous month.

There was a similar picture in France, where inflation continued to fall in February, as faster growth in energy prices and steady increases in services prices offset a sharp slowdown in food costs. But French household spending declined 0.3 per cent in January.

Slower growth in French food and manufactured goods prices drove inflation in the eurozone’s second-largest economy down to 3.1 per cent in the year to February, from 3.4 per cent a month earlier, the national statistics agency said on Thursday.

The latest French reading was its lowest level since September 2021 but was slightly above the 3 per cent level forecast by economists in an earlier Reuters poll.

Inflation in Spain fell in line with forecasts to 2.9 per cent in February, taking it back below 3 per cent for the first time in six months. But an acceleration in fuel prices partly offset lower growth in electricity costs, according to the country’s statistics office.

Eurozone-wide inflation data is expected to fall from 2.8 per cent in January to 2.5 per cent in February when official figures are released on Friday.

ECB president Christine Lagarde told the European parliament this week that price growth was expected to “continue slowing down, as the impact of past upward shocks fades and tight financing conditions help to push down inflation”. 

However, Lagarde said wage growth remained strong and would be “an increasingly important driver of inflation dynamics in the coming quarters, reflecting employee demand for inflation compensation and tight labour markets”. 

The ECB plans to release new price growth forecasts after its meeting next week. Goldman Sachs expects it to cut its forecast for eurozone inflation this year from 2.7 per cent to 2.3 per cent and for next year from 2.1 per cent to 2 per cent — in line with the ECB’s target.

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