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Eurozone inflation falls to lowest level since Russia invaded Ukraine

Eurozone inflation has fallen more than economists expected to hit its lowest level since Russia’s invasion of Ukraine more than a year ago, but the head of the European Central Bank signalled more interest rate rises were needed to tame persistent price pressures.

Annual consumer prices in the 20-country single currency bloc rose 6.1 per cent in the year to May, a decline from 7 per cent in April, according to data published by the EU statistics agency Eurostat on Thursday. It is the lowest level since February 2022 and was below the 6.3 per cent forecast by economists in a Reuters poll.

ECB president Christine Lagarde said in a speech shortly after the data was released that inflation was still “too high” and more interest rate rises were needed to bring it down to its 2 per cent target.

Eurozone rate-setters are particularly focused on core inflation, which strips out energy and food prices. This measure fell from 5.6 per cent in April to 5.3 per cent in May, which was more than expected but seemed unlikely to convince policymakers to stop raising rates at their next meeting on June 15.

Eurozone sovereign bond markets fell and the euro rose against the dollar as investors bet inflation was not falling fast enough for the ECB to stop raising rates. Germany’s rate-sensitive two-year bond yield rose 4.8 basis points to 2.76 per cent, while the euro gained 0.25 per cent to $1.072.

Economists said the fall in core inflation was in large part due to the impact of Germany’s launch of a subsidised €49-a-month public transport ticket in May, which damped growth in transport service prices.

“While further gradual declines in the core rate seem likely, we don’t think that will stop the ECB from raising interest rates in June and probably July,” said Jack Allen-Reynolds, an economist at research group Capital Economics.

Annual inflation fell in 18 out of the 20 eurozone member countries, rising only in the Netherlands. Price pressures also cooled in all product areas for the first time since they started to rise at the fastest pace for a generation more than 18 months ago. 

But Lagarde cautioned that “there is no clear evidence that underlying inflation has peaked”. While eurozone lending has stalled, Lagarde told a German banking event in Hannover that ECB consumer surveys “show that tighter monetary policy is not going to affect people’s holiday plans”.

The ECB has already raised its deposit rate at an unprecedented pace from minus 0.5 per cent last July to 3.25 per cent in May. Investors are betting it will lift rates by another quarter-percentage point at its next meeting in two weeks’ time and once more in July before pausing.

Line chart of  showing Eurozone inflation is following the US down, but with a lag

A number of ECB governing council members only agreed to support a smaller rate rise of a quarter percentage point in May if it also signalled that more rate rises were coming, according to the official account of its last policy meeting published on Thursday.

Some council members said smaller rate rises would allow them to “keep raising rates for longer, if underlying inflation pressures persisted or even strengthened through the summer”. It was even “contended that signs of a wage-profit-price spiral were emerging” by some rate-setters.

Price pressures have stayed higher in the eurozone than in the US, where consumer price inflation fell to 4.9 per cent in April. Prices in both the eurozone and the US have cooled faster than the UK, where inflation hit 8.7 per cent in April.

Rising wage growth is “becoming a more important driver of inflation,” Lagarde warned. While eurozone workers have suffered a 4 percentage point fall in real wages since the pandemic hit in 2020, she said tight labour markets meant they “have considerable bargaining power, which they are starting to use to recoup these losses”.

Eurozone unemployment fell to a new record low of 6.5 per cent in April, separate Eurostat data showed on Thursday.

Eurozone energy prices fell 1.7 per cent from a year ago in May, after rising 2.4 per cent in the previous month. Services inflation dipped from 5.2 per cent to 5 per cent, while goods inflation eased from 6.2 per cent to 5.8 per cent. 

Lagarde said falling energy prices should “limit firms’ ability to further raise profit margins, which has been a key factor driving recent price pressures”. It was the ECB’s responsibility to “restrict demand enough” to prevent a self-reinforcing spiral of wages, profits and prices, she said.

Food prices cooled slightly in May, while still rising at a rapid rate. Fresh food inflation dipped from 10 per cent to 9.6 per cent, while the price of processed food, alcohol and tobacco rose 13.4 per cent — down from 14.6 per cent a month earlier.

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